Cash flow

  • A statement of change financial position on a cash basis commonly known as the cash flow statement, Summarises the causes of change in cash position between dates of the two balance sheet, It indicates the source and uses of cash.
    Thus, this is statement analysis changes in non-current accounts as well as current accounts.

Sources and uses of cash

Sources of cash.

->The profitable operation of the firm.
->Decrease in assets(except cash)
->Increase in liabilities (including) debenture or bonds.
->Sale proceeds from an ordinary or preference share issue.

Uses of cash

->The loss from an operation
->increase in assets(except cash)
->decrease in liabilities
->redemption of redeemable preference share.
->Cash dividends

The easiest and the direct method of preparing a statement of changes in cash position is to only record inflow and outflow of cash and find out the net change during a given period.

The rupee received minus the rupees paid during a period is the cash position has to be found out from the income statement and comparative balance sheet. Adjustment for the no cash items is made.

Change in current assets

An increase is current assets reduce the cash flow from operations while a decrease in current assets. that is, the beginning balance exceeding and of the year balance increase cash flow.

i)Increase in debtors implies that cash collection from customers or less them sales figure shown in the profit and loss statement while a decrease in debtors indicates that cash collections are greater than the sales figures.

ii)Increase or decrease in inventory adjusted to the cost of goods sold. An increase in inventory implies that cash outflow is greater than the cost of goods sold figure(shown in the profit and loss statement), while a decrease in inventory means that cash outflow is 100 than the cost of goods sold figure.

iii)Increase in prepaid expenses implies that cash outflow is more than the amount of actual expenses(shown in profit and loss statement, while a decrease in prepaid expenses means that cash outflow is less than the amount of actual expenses.

Change in current liabilities

increases in current liabilities increase cash flow from operation while a decrease in current liabilities reduces it.

i)Increase in creditors implies that cash payments to creditors are less than the purchase figure.
While a decrease in creditors indicates that cash payments to creditors are greater than purchase.

ii)Increase in ‘income in advance’ implies greater cash inflow than shown in the profit and loss statement as income, while a decrease in ‘income in advance’ means less cash inflow than shown as income.

Component of cash flow

i)Initial investment
ii)Annual net cash flows
iii)Terminal cash flow

Initial Investment

The initial investment is the net cash outlay in the period in which an asset is purchased. A major element of the initial investment is gross outlay or original value(ov) of the asset, which comprises of its cost (including accessories and spare parts) and freight and installation charges.

The original value included in the existing block of assets for computing annual depreciation. Original value minus depreciation is the assets’ book value(BV). It may require a lump sum investment in net working capital also.

Thus initial investment will be equal to gross investment plus an increase in networking capital also.

ii)Net Cash flows

An investment expected to generate annual cash flows from operations after the initial cash outlay has been made. Cash flows should always be estimated on an after-tax basis. Some people advocate the computing of cash flows before taxes and discounting them at the before-tax discount rate to find NPV.

Unfortunately, this will not work in practice since there does not exist an easy and meaningful way for adjusting the discount rate on a before-tax basis.

We shall refer to the after-tax cash flow as net cash flows(NCF) and use the term C_{1},C_{2},C_{3}....C_{n} respectively for NCF in period 1,2,3,……n.

Net cash flow =Revenue-Expenses-Taxes

3)Terminal cash flow

Salvage value (SV) is the most common example of terminal cash flows. Salvage value  defined as the market price of an investment at the time of its sale. The cash proceeds net of an investment at the time of its sale. The cash proceeds net of taxes from the sale of the assets treated as cash inflow in the terminal (last) year.

The effect of the salvage value of existing and new assets summarised as follows.

i)Salvage value of the asset-It will increase cash inflow in the terminal(last) period of the new investment.
ii)Salvage value the existing asset now-It will reduce the initial cash outlay of the new asset.
iii)Salvage value of the existing asset at the end of its normal life-It will reduce the cash flow of the new investment of in the period in which the existing asset sold.



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