Chapter 6 Cash Flow Statement Solutions
Question - 1 : - What is a Cash Flow Statement?
Answer - 1 : -
A financial statement that represents the inflow and outflow of cash and cash equivalents of a company is called a cash flow statement. It shows how well a company can manage its cash position and generates enough cash to pay the obligations in the form of debt and also run the operational expenses.
Question - 2 : - How are the various activities classified (as per AS-3 revised) while preparing cash flow statement?
Answer - 2 : -
Three types of activities are defined:
1. Operating Activities
2. Financing Activities
3. Investing Activities
Question - 3 : - State the uses of cash flow statement?
Answer - 3 : -
Following are uses of cash flow statement:
1. Useful for evaluating cash position of a firm
2. Helpful in finding deficiencies and variations in firms performance which helps in effective decision making
3. It helps in assessment of liquidity of a company
4. It analyses cash receipts and payments from the various activities of a company and helps in short term planning
5. It helps in segregating cash flows obtained from the various activities of the business
6. It helps in providing decision about distribution of profit.
7. It is useful for short term financial analysis
Question - 4 : - What are the objectives of preparing cash flow statement?
Answer - 4 : -
Following are the objectives:
1. To determine inflow and outflow of cash and the cash equivalents obtained from the different kind of activities.
2. To seek out various reasons responsible for change in cash balances during the accounting period
3. It helps in depicting the position of the company in terms of liquidity and solvency
4. It also helps in determining the requirement and the corresponding availability of cash for business in future.
Question - 5 : - State the meaning of the terms: Cash Equivalents, Cash flows.
Answer - 5 : -
Cash equivalents are investments that are highly liquid in nature and do not change value easily. Cash equivalents are essential for managing short term cash requirements or any such investments. For example treasury bills.
Cash Flows: It is the inflow and outflow of cash and cash equivalents. Cash inflows boosts cash balance and cash outflow has a negative impact on cash balance
Question - 6 : - Prepare a format of cash flow from operating activities under indirect method.
Answer - 6 : - The format is as follows:
Question - 7 : - State clearly what would constitute the operating activities for each of the following enterprises:
(i) Hotel
(ii) Film production house
(iii) Financial enterprise
(iv) Media enterprise
(v) Steel manufacturing unit
(vi) Software development business unit.
Answer - 7 : -
(i) Hotels
1. Receipts obtained from sale of goods to customers.
2. Customer stay, payments of wages and salaries, food items and electricity are operating activities
(ii) Film Production House:
1. Receipts obtained from selling of film rights to distributors
2. Payment provided to actor, actresses, directors and other employees.
(iii) Financial Enterprises:
1. Receipts obtained from loan repayments, interest received from investments
2. Salary for employees, expenditure incurred for recovering loans, loan repayment etc
(iv) Media Enterprises:
1. Receipts that are obtained from various advertisements
2. Payments made to photographers, employees and reporters
(v) Steel Manufacturing Unit:
1. Receipts obtained from sale of steel rods, castings and sheets.
2. Payments made for purchasing iron, coal and salaries to staff.
(vi) Software Development Business Unit:
1. Receipts obtained for software sales and license renewal
2. Payments towards salaries of employees
Question - 8 : - “The nature/type of enterprise can change altogether the category into which a particular activity may be classified.” Do you agree? Illustrate your answer.
Answer - 8 : -
Yes, it can happen. For example, there are two firms one is engaged in real estate and the other in general business. For the firm engaged in real estate sale of building will be regarded as part of operating activity while for the firm dealing with general business, purchase or sale of a building is regarded as an investing activity. Therefore, it can be said that nature and type of enterprise determines the type of activities.
Question - 9 : - Describe the procedure to prepare Cash Flow Statement.
Answer - 9 : -
Following steps are followed:
1. Determine cash flows obtained from operating activities
2. Determine cash flows obtained from financing activities
3. Determine cash flow obtained from investing activities
4. Determine net increase or decrease which is obtained by adding amounts from all the cash flow activities.
5. Add the opening balance of cash and the cash equivalents and deduct the same from the amount determined in the previous step.
There are two methods which are used for preparation of cash flow statement
1. Direct Method
2. Indirect Method.
Question - 10 : - Describe “Indirect” method of ascertaining Cash Flow from Operating Activities.
Answer - 10 : -
In indirect method cash flow statement begins with net income or loss, and thereafter the additions or deductions from that amount for non-cash expense and revenue items, which results in cash flow from operating activities. Following are some items:
1. Items that are non-cash in nature like goodwill, depreciation are added towards net profit
2. Expenses that are non-operating in nature like transfer to reserve and loss on sale of fixed assets which are added back to show Net Profit earned.
3. Provision such as discount for debtors, doubtful debts, proposed dividends etc. should be added to Net Profit
4. Any decrease in current assets and an increase in current liabilities is added to operating profit.
Following items get deducted from net profit of P & L account
1. Incomes that are non-operating in nature like sale of fixed assets
2. Non-trading incomes like dividend received, tax refund, interest received
3. Increase in current assets and decrease in current liabilities