Cash Flow Statement

CASH FLOW STATEMENT:

In financial accounting, a cash flow statement, also known as statement of cash flows. A cash flow statement is a statement which describes the inflows and outflows of cash and cash equivalents of an enterprise during a specified period of time. Such a statement enumerated net effects of various business transaction on cash and its equivalents and takes into account receipts and disbursements of cash. A cash flow statement summarises the causes of changes in cash position of a business enterprise between dates of two balance sheets. According to Accounting Standards 3 (Revised), an enterprise should prepare a cash flow statement and should present it for each period for which financial statements are prepared.

Information about cash flows of an enterprise is useful in providing users a financial statement with a basis to assess ability of the enterprise to generate cash and cash equivalents and the needs of the enterprises to utilize those cash flows. The economic decisions that are taken by the users require an evaluation by the ability of an enterprise to generate cash and cash equivalents and the timing and the certainty of their generation.

According to Accounting Standard 3 (Revised), the cash flow statement should report cash flows during the period classified by operating, investing and financing activities. Thus cash flows are classified into three main categories.

Three Sections of the Statement of Cash Flows: 1. Operating Activities: The principal revenue-generating activities of an organization and other activities that are not investing or financing; any cash flows from current assets and current liabilities. 2. Investing Activities: Any cash flows from the acquisition and disposal of long-term assets and other investments not included in cash equivalents. 3. Financing Activities: Any cash flows that result in changes in the size and composition of the contributed equity capital or borrowings of the entity (i.e., bonds, stock, dividends)

METHODS OF CALCULATING CASH FLOW FROM OPERATING ACTIVITIES: 1. Direct Method:

The direct method for creating a cash flow statement reports major classes of gross cash receipts and payments. Under IAS 7, dividends received may be reported under operating activities or under investing activities. If taxes paid are directly linked to operating activities, they are reported under operating activities; if the taxes are directly linked to investing activities or financing activities, they are reported under investing or financing activities. Generally Accepted Accounting Principles (GAAP) vary from International Financial Reporting Standards in that under GAAP rules, dividends received from a company's investing activities is reported as an "operating activity," not an "investing activity.

2. Indirect Method:

The indirect method uses net-income as a starting point, makes adjustments for all transactions for non-cash items, then adjusts from all cash-based transactions. An increase in an asset account is subtracted from net income, and an increase in a liability account is added back to net income. This method converts accrual-basis net income (or loss) into cash flow by using a series of additions and deductions.

OBJECTIVES: 1. To identify the reasons of increase or decrease in the cash position of the firm during the specific period. 2. To highlight the cash generated from activities. 3. For the effective and efficient management of cash. 4. Comparison with the cash budget. 5. Cash flow information helps to understand the liquidity.

USES AND SIGNIFICANCE:

Cash flow statement is very useful in the evaluation of the cash position of a firm. A projected cash flow statement can be prepared in order to know the future cash positions of a concern so as to enable a firm to plan and coordinate its financial operations properly, by preparing this statement, a firm can come to know as to how much cash can be generated into the firm and how much cash will be needed to make the various payments and hence the firm can well plan to arrange for the future requirements.

A comparison of the historical and the projected cash flow statements can be made so as to find the variations and deficiency or otherwise in the performance so as to enable the firm to take immediate and effective actions.

Cash flow statements helps in planning the repayments of loans, replacement of fixed assets and other similar long term planning of cash. It is also significant for the Capital Budgeting decisions.

A series of intra firm and inter firm cash flow statements reveals whether the firm’s liquidity (short term paying capacity) is improving or deteriorating over a period of time and in comparison to other firms over a period of time.

Cash flow analysis is more useful and appropriate than fund flow analysis for short term financial analysis as in a very short period it is cash which is more relevant than a working capital for forecasting the ability of the firm to meets its immediate obligations.

SCOPE:

An entity shall prepare Cash Flow Statements in accordance with the requirements of the standard and shall present it as an integral part of its financial statements of each period and is mandatory to prepare by the listed companies.

NEED FOR STUDY: 1. As per International Accounting Standard 7 requires an enterprise to present a cash flow statement as part of the financial statement. 2. It summarises the financial statements of an entity cash receipts and payments during a period. 3. To compare the performance of the companies for cash flows not affected by accounting policies. 4. Assess company ability to generate cash and cash equivalents. 5. It predicts an entity ability to generate positive future cash flows meet current & long term obligations.

LIMITATIONS: 1. As cash flow statement is based on cash basis of accounting, it ignores the basic accounting concept of accrual basis. 2. Cash flow statement is not suitable for the judging the profitability of a firm as noncash charges is ignored while calculating cash flows from operating activities. 3. The cash flow statements is not a substitute of an income statement, it is complimentary to an income statement. 4. It indicates only the past position and not the future. 5. It does not give the complete picture of the financial position of the business concern.

RESEARCH AND METHODOLOGY: All the research of the data has been collected from a secondary source. The financials of the chosen firms were audited and then published onto financial sites and the data is also collected from journals and magazines.

INTRODUCTION:

Generally, the purpose of a review is to analyse critically a segment of a published body of knowledge through summary, classification, and comparison of prior research studies, reviews of literature, and theoretical articles. The main objective to achieve in the literature review is developing knowledge and understanding of the previous work or activity in regard to the topic being researched. The literature review also addresses the importance and need to inform the investigator as to the main findings, trends, area of debate or controversy, area of neglect and suggestions research. There are hundred books and papers about cash flow and accrual accounting but there are few books and papers about both the topic together. In this chapter, researcher has tried to collect data from research papers, theses and books related to this study. The goal of this chapter is to collect the literature review by considering the key theoretical issues related to the research proposal. That means using accrual accounting and cash flow data in predicting future cash flow and to present models of cash flow prediction.

Oliver Kim (2007) 120 tested the validity of using one year ahead cash flow prediction as a substitute for the value relevance test of earning and this study searched about cash flow prediction but not mentioned anything about accrual accounting. Therefore, finder found the ability of earnings to predict one year –ahead cash flow has increased over the recent decades, in contrast to the evidence that both factors that the cash flow prediction test is a poor

substitute

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the

value

relevance

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earning.

Lambert et al. (2007) 124 suggested that firms with more precise information about future cash flows have lower conditional co variances with the market, and as a consequence, lower conditional betas and lower expected returns. Overall, the following two-step link is suggested by the estimation risk literature: 1.

Firms with higher information quality have lower forward-looking betas;

2.

Lower forward-looking betas lead to lower cost of equity.

Note that the forward-looking betas cannot be directly estimated from the past return realizations.

Ali Rkein (2008) 126 worked in accrual accounting and public sector and his conclusion was, the northern territory Government introduced on accrual framework for its accounting, budgeting and reporting into its public sector with the intention that this framework would lead to an improved performance and accountability. This framework has been developed in private sector and introduced in public sectors as Governments started to take a more commercial direction by subjecting public services to competition and market principle. The study does not mention cash flow and its future prediction in private and public company sectors but my study focuses in accrual accounting and predicting future cash flow in reality. I have tried to accommodate those subjects together.

Maria Ogneva (2008) 127 found out document that accrual quality is inversely related to the cost of equity capital. However, found no association between accrual quality and future stock returns and conclude that there is no evidence that the stock market prices accrual quality. The researcher hypothesize that Maria Ogneva result arises because poor accrual quality firms experience negative cash flow shocks in the future, which results in negative returns that offset the higher expected returns for such firms. Consistent with this prediction, researcher find a significant negative association between realized returns and accrual quality after controlling for cash flow shocks, either by including proxies for future cash flow shocks in asset pricing regressions or by using an accrual quality measure that is less correlated with future cash flow shocks. This result is robust to properly specified and standard asset pricing tests. Overall, this paper adds to the growing literature suggesting that accrual quality is linked to the cost of capital.

Khodadadi et al (2009) 135 investigated the ability of cash and accruals accounting information of profit in prediction of future cash flows of listed companies in Tehran Stock Exchange. The investigated sample of that study was selected among non-financial firms listed in Tehran Stock Exchange whose financial statements were available in the period 2001-2006. The results of their study showed that variables of past cash flows and accrual components of past earnings had ability to predict future cash flows. The results of testing their models indicated that the addition of accrual components of earnings into cash flows increased the predictive power of this model.

Linda M. Nichols (2009) 134 found out whether teaching the indirect or direct method of explaining the difference between accrual operating income and cash flow from operations is more effective in helping students understand the concept of accrual versus cash accounting. One expects that because business students are accustomed to using accrual based financial statements, they will understand cash flows better when presented with the indirect method which starts with accrual based income and adjust it to be on a cash basis.

Thomas. H. Beechy (2010) 136 discussed about 3 factors which are: ●

The nature and components of full accrual accounting;

●

The relationship between relevance sources and the costs of delivering goods and

services; ●

The distinction between private goods and public (collective) goods.

About item number one the researcher says that full accrual accounting is not a single concept and it constitutes several accounting concepts such as: 1) Accrual accounting 2) expenses recognition 3) inter period allocation. Every organization should use accrual accounting but applicability of the other two concepts depends on the nature of the organization. The most of Non-profit organizations provide goods are those that can be enjoyed by only a limited number of beneficiaries, their use by some individuals makes them unavailable to other once the supply is used up. Private goods have a determinable output and therefore, a measurable cost. Often, on nonprofit organizations that provide goods and services gets its revenue from one or both of two sources. General revenues contributed by dues or other membership fees. User’s fees charged for the private goods it delivers. User fees can be paid by either the user or by someone else on the fees are paid; they are intended to cover the full cost of providing the services. Therefore, in these situations the expense bias is appropriate.

Choong Yuel (2011) 139 understood, analysts’ cash flow forecasts have become widely available through financial services. Cash flow information enables practitioners to have a better understand the real operating performance and financial stability of a company, practically when earning information is noisy and of low quality.

Jenis Cormier (2012) 142 mentioned that the finance manager may use the received funds management to voluntary receive funds forecasting. Put on document of the range of earning management guarantee with Canadian Initial Public Offerings (IPOs) and study the scope to which firms with best corporate control systems are less likely to use achieving funds management to obtain their achieving funds estimates forecasting IPOs prospectus.

Farzin Rezaei, and Zahra Safari (2013) 144 reported determining the effective factors on market value of equity can help shareholders to make an appropriate decision and allocate economic resources efficiently. Profitability of companies is one of the most important criteria for investors to assess companies, but relying on net profit regardless of its constituent items will lead to loss of important and effective information on decision making and therefore making improper decisions. The present study was carried out in order to investigate and compare the explanatory power of different components of profit including operating cash flow OCF, current accruals, and non-current accruals and free cash flow, as well as to help explain the behaviour of abnormal accruals in Tehran Stock Exchange. The results indicate that information content of cash components of earnings is higher than other components of earnings and also findings of the research show that division of profit into two components of operating cash flow and accruals relative to other profit combinations has a higher explanatory value.