How to Make a Cash Flow Statement and Analyze Its Accuracy
How to Make a Cash Flow Statement and Analyze Its Accuracy
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| cash flow statement |
Introduction
A Cash Flow Statement (CFS) is a crucial financial report that provides insights into a company’s liquidity by tracking the inflows and outflows of cash. While the Income Statement and Balance Sheet show profitability and financial position, the Cash Flow Statement ensures a company’s cash health remains intact.
In this article, we’ll cover:
- How to prepare a Cash Flow Statement
- How to verify if the cash flow statement presents an accurate financial picture
- Practical tools and techniques for cash flow analysis
- A detailed example demonstrating cash flow accuracy analysis
Sections of a Cash Flow Statement
A Cash Flow Statement is divided into three main sections:
1. Cash Flow from Operating Activities (CFO)
This section shows cash flows related to the core business operations, including revenues and expenses. It is calculated using either:
- Direct Method: Lists actual cash receipts and payments.
- Indirect Method: Starts with Net Income and adjusts for non-cash transactions.
2. Cash Flow from Investing Activities (CFI)
This section records cash transactions related to long-term investments, such as:
- Purchase or sale of fixed assets (machinery, land, buildings)
- Investment in securities (stocks, bonds)
- Loans given to or received from other entities
3. Cash Flow from Financing Activities (CFF)
This section includes cash flows related to financing sources like debt and equity:
- Issuing or repurchasing shares
- Borrowing or repaying loans
- Paying dividends
Steps to Prepare a Cash Flow Statement
Step 1: Gather Financial Data
You need the company’s Income Statement and Balance Sheet to extract relevant financial figures.
Step 2: Calculate Cash Flow from Operating Activities (CFO)
Using the Indirect Method, start with Net Profit and adjust for non-cash items and changes in working capital.
Step 3: Identify Investing Activities (CFI)
List transactions related to asset purchases or sales.
Step 4: Determine Financing Activities (CFF)
Account for activities related to debt and equity financing.
Step 5: Compute Net Cash Flow
Add up cash flows from all sections:
Step 6: Validate with Bank Statements
Ensure the closing cash balance matches the cash reported in the Balance Sheet.
How to Verify the Accuracy of a Cash Flow Statement
To confirm if the Cash Flow Statement represents an accurate financial picture, apply the following techniques:
1. Compare with Other Financial Statements
- Balance Sheet Cross-Check: Ensure the cash balance matches the reported closing cash balance.
- Profit vs. Cash Flow: A company showing high profits but negative cash flow may be facing liquidity problems.
2. Analyze Trends Over Time
- Compare cash flow data across multiple periods.
- Identify recurring cash flow issues (e.g., increasing financing activities but declining operational cash flow).
3. Check Cash Conversion Efficiency
- Cash Flow to Net Income Ratio = CFO / Net Income
- A high ratio indicates efficient earnings conversion into cash.
4. Evaluate Free Cash Flow (FCF)
- A positive FCF indicates strong operational performance and the ability to invest in growth.
Practical Example of Cash Flow Analysis
Let’s consider XYZ Ltd., a manufacturing company, and prepare its Cash Flow Statement for FY 2024-25.
Given Financial Data:
| Particulars | Amount (INR) |
|---|---|
| Net Income | 15,00,000 |
| Depreciation | 2,00,000 |
| Increase in Accounts Receivable | (1,00,000) |
| Increase in Inventory | (50,000) |
| Increase in Accounts Payable | 80,000 |
| Purchase of Machinery | (4,00,000) |
| Sale of Investments | 3,00,000 |
| Loan Taken from Bank | 5,00,000 |
| Dividend Paid | (1,50,000) |
Cash Flow Statement of XYZ Ltd.
| Particulars | Amount (INR) |
|---|---|
| Cash Flow from Operating Activities | |
| Net Income | 15,00,000 |
| Add: Depreciation | 2,00,000 |
| Less: Increase in Accounts Receivable | (1,00,000) |
| Less: Increase in Inventory | (50,000) |
| Add: Increase in Accounts Payable | 80,000 |
| Net CFO | 16,30,000 |
| Cash Flow from Investing Activities | |
| Less: Purchase of Machinery | (4,00,000) |
| Add: Sale of Investments | 3,00,000 |
| Net CFI | (1,00,000) |
| Cash Flow from Financing Activities | |
| Add: Loan Taken from Bank | 5,00,000 |
| Less: Dividend Paid | (1,50,000) |
| Net CFF | 3,50,000 |
| Total Net Cash Flow | 18,80,000 |
Key Observations from XYZ Ltd.’s Cash Flow
- Strong Operational Cash Flow (₹16,30,000) indicates the company is generating cash efficiently from core operations.
- Negative Investing Cash Flow (₹1,00,000) suggests the company is expanding by purchasing machinery.
- Positive Financing Cash Flow (₹3,50,000) due to bank loans shows dependency on external funding.
- The company’s closing cash balance aligns with the Balance Sheet, confirming data accuracy.
Tools for Cash Flow Statement Analysis
1. Excel-Based Financial Models
- Create dynamic cash flow tracking sheets.
- Use formulas for trend analysis and ratios.
2. Financial Software Tools
- Tally ERP 9 & QuickBooks: Automates cash flow tracking.
- Zoho Books: Generates real-time cash flow insights.
3. Ratio Analysis Tools
- Cash Flow to Debt Ratio (CFO / Total Debt) assesses debt repayment capacity.
- Operating Cash Flow Margin (CFO / Revenue) evaluates cash profitability.
1. Understanding Cash Flow Statements as per Accounting Standards (Ind AS 7 & AS 3)
The cash flow statement is one of the key financial statements that show the movement of cash and cash equivalents during a financial period. It helps businesses and investors understand liquidity, solvency, and overall financial health.- Ind AS 7 – Statement of Cash Flows (for companies following Ind AS)
- AS 3 – Cash Flow Statements (for companies following Indian GAAP)
2. Classification of Cash Flows as per Ind AS 7 & AS 3
| Category | Description | Examples |
|---|---|---|
| Operating Activities | Cash flows from the core revenue-generating activities of a business. | Cash received from customers, payments to suppliers, salaries, rent, interest paid on working capital loans. |
| Investing Activities | Cash flows from the purchase and sale of long-term assets. | Purchase of property, plant, and equipment (PPE), investment in securities, proceeds from asset sales. |
| Financing Activities | Cash flows from financial transactions affecting capital structure. | Issuance of shares, borrowing/repayment of loans, dividend payments. |
- Bank Overdrafts: Ind AS 7 treats bank overdrafts as cash equivalents, whereas AS 3 treats them as financing activities.
- Interest & Dividends: Ind AS 7 allows flexibility in classifying interest & dividend payments (either operating or financing), whereas AS 3 mandates specific classifications.
3. Methods of Preparing a Cash Flow Statement
A. Direct Method (Preferred as per Ind AS 7 & AS 3)
- Cash inflows and outflows from operations are presented directly.
- Example:
Cash collected from customers: ₹10,00,000 Less: Cash paid to suppliers: ₹6,00,000 Less: Salaries paid: ₹1,50,000 Net Cash Flow from Operating Activities: ₹2,50,000 B. Indirect Method (Most Common in Practice)
- It starts with net profit from the income statement and adjusts for non-cash transactions.
- Formula:
Net Profit (+) Depreciation/Amortization (+/-) Changes in Working Capital (+) Non-cash expenses (e.g., Bad Debts, Deferred Taxes) (-) Non-operating incomes (e.g., Profit on Sale of Asset) = Cash Flow from Operations | Particulars | Amount (₹) |
|---|---|
| Net Profit (as per P&L) | 5,00,000 |
| Add: Depreciation | 1,00,000 |
| Add: Loss on Sale of Asset | 20,000 |
| Less: Increase in Receivables | (50,000) |
| Less: Increase in Inventory | (30,000) |
| Net Cash Flow from Operations | ₹5,40,000 |
4. Items to be Added & Deducted While Preparing a Cash Flow Statement
| Item | Treatment in Cash Flow |
|---|---|
| Depreciation & Amortization | Add back (Non-cash expense) |
| Interest Paid | Deduct (Financing activity) |
| Interest Received | Add (Investing activity) |
| Dividend Received | Add (Investing activity) |
| Dividend Paid | Deduct (Financing activity) |
| Loss on Sale of Fixed Asset | Add back (Non-cash item) |
| Gain on Sale of Fixed Asset | Deduct (Non-operating income) |
| Increase in Inventory | Deduct (Cash used in operations) |
| Decrease in Inventory | Add (Cash generated from operations) |
| Increase in Debtors | Deduct (Cash used in operations) |
| Decrease in Debtors | Add (Cash generated from operations) |
5. Tools for Analyzing a Cash Flow Statement
A. Free Cash Flow (FCF) Analysis
FCF = Cash Flow from Operations – Capital Expenditure- If FCF is positive, the company has surplus cash for expansion.
- If FCF is negative, the company may need external funding.
B. Operating Cash Flow to Net Income Ratio
OCF to Net Income = Operating Cash Flow / Net Profit- > 1: Strong cash flow conversion (good financial health).
- < 1: The company is reporting profits but struggling with liquidity.
C. Cash Flow Margin Ratio
Cash Flow Margin = Operating Cash Flow / Revenue- Shows how much of a company’s revenue is converted into cash.
- A higher ratio indicates better financial efficiency.
6. Practical Example – Analyzing a Cash Flow Statement
Profit & Loss Statement of ABC Ltd.
| Particulars | Amount (₹) |
|---|---|
| Revenue | 50,00,000 |
| Operating Expenses | (30,00,000) |
| Depreciation | (5,00,000) |
| Interest Paid | (2,00,000) |
| Profit Before Tax | 13,00,000 |
| Tax @ 30% | (3,90,000) |
| Net Profit | ₹9,10,000 |
Cash Flow Statement of ABC Ltd.
| Particulars | Amount (₹) |
|---|---|
| Operating Activities: | |
| Net Profit | 9,10,000 |
| Add: Depreciation | 5,00,000 |
| Less: Increase in Debtors | (1,50,000) |
| Add: Increase in Creditors | 2,00,000 |
| Net Cash from Operating Activities | ₹14,60,000 |
| Investing Activities: | |
| Purchase of Machinery | (6,00,000) |
| Sale of Old Equipment | 2,50,000 |
| Net Cash from Investing Activities | (₹3,50,000) |
| Financing Activities: | |
| Loan Taken from Bank | 5,00,000 |
| Dividend Paid | (2,00,000) |
| Net Cash from Financing Activities | ₹3,00,000 |
| Net Increase in Cash | ₹14,10,000 |
- A positive operating cash flow of ₹14.6 lakh suggests strong liquidity.
- Investment in machinery shows expansion plans.
- Loans raised of ₹5 lakh help finance expansion.
- Dividend payments indicate shareholder returns.
7. Key Takeaways for Readers
✔️ Compare cash flow from operations with net income – A lower ratio could signal accounting adjustments.✔️ Watch out for increasing receivables & inventory. High sales on credit can mask liquidity issues.
✔️ Check free cash flow (FCF). A negative FCF despite high net profit can indicate trouble.
Conclusion
A Cash Flow Statement is a vital financial document that offers deep insights into a company’s liquidity. By preparing an accurate cash flow statement and analyzing trends, businesses can make informed financial decisions. Using tools like Excel models, financial software, and ratio analysis enhances accuracy and effectiveness.
Understanding cash flow helps investors, financial analysts, and business owners make better strategic decisions. By applying practical techniques and tools, one can ensure that the reported cash flow presents a true and fair view of financial health.
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