Analysis and Interpretation of Financial Statement.pptx

Comparative-Study-Between-Private-Sector-Banks

1. Analysis and Interpretation of Financial Statements

2. Corporate Accounting Corporate accounting  refers to the process of maintaining financial records and preparing financial statements for corporations operating in the country as required by the  Companies Act, 2013 . The main objective of corporate accounting is to ensure that companies comply with statutory and regulatory requirements, while also providing accurate and reliable financial information to stakeholders such as shareholders, creditors, and regulatory bodies. Corporate Accounting is considered a special branch of accounting dealing with the accounting for companies.

3. Companies are required to maintain various books of accounts, such as a cash book, a journal, and a ledger, in addition to preparing financial statements such as a balance sheet, a profit and loss account, and a cash flow statement. These financial statements must be prepared in accordance with generally accepted accounting principles (GAAP), which are prescribed by the  Institute of Chartered Accountants of India (ICAI) . corporate accounting in India is a complex process that requires a thorough understanding of accounting principles, tax laws, and regulatory requirements. Companies typically rely on qualified chartered accountants or accounting firms to manage their accounting functions and ensure compliance with all relevant laws and regulations.

4. What is corporate accounting? Corporate accounting  refers to the process of  recording, classifying, summarizing , and analyzing financial transactions of a company or corporation. The objective of corporate accounting is to provide accurate and timely financial information that helps company management make informed decisions and comply with statutory and regulatory requirements. The key tasks involved in  corporate accounting  include bookkeeping, which involves recording financial transactions such as sales, purchases, receipts, and payments, and preparing financial statements such as the balance sheet, income statement, and cash flow statement. These financial statements provide information about the company's financial performance, liquidity, and solvency.

5. Importance of Corporate Accounting: Accounting is an essential activity for corporate entities, as we have seen. The purpose of accounting is for companies to analyse their financial position and predict future business decisions. The activity is also important to: Corporate accounting is essential for the following reasons: 1. Compliance with numerous statutory and regulatory requirements related to accounting, tax, and financial reporting is necessary for a company.  Corporate Accounting  ensures that the companies comply with these requirements and provide accurate financial information to stakeholders.

6. 2. Corporate accounting helps in the decision-making process by providing relevant financial information that helps management make informed decisions about investments, financing, pricing, and resource allocation. 3. It also helps in building investors' confidence and attracting investments through accurate and timely financial reporting. 4. Corporate accounting aids in risk management by helping companies to identify and manage financial risks, such as credit risk, market risk, and liquidity risk.

7. 5. Corporate accounting initiates Accountability by providing a mechanism for companies to be accountable to stakeholders, such as shareholders, creditors, and regulatory bodies. 6. It provides financial data that makes performance evaluation possible for companies and makes necessary adjustments to improve efficiency and profitability.

8. Benefits of Corporate Accounting: Corporate accounting offers several benefits to companies, which include: 1.  Accurate financial information:  To provide a clear picture of the company's financial position, performance, and cash flow, Corporate accounting makes sure that accurate and timely financial records are being maintained by the company. 2.  Compliance with legal and regulatory requirements: The purpose of corporate accounting is to ensure that companies comply with legal and regulatory requirements regarding  financial reporting, taxation, and accounting .

9. 3.  Better decision-making: Accounting informs management about investments, financing, pricing, and resource allocation by providing financial data and analysis. 4.  Improved efficiency and profitability: It helps companies to identify areas of inefficiency and take corrective action to improve performance and profitability. 5.  Benchmarking: financial data that allows companies to compare their performance with industry benchmarks and make necessary adjustments to improve efficiency and profitability is ensured by corporate Accounting. .

10. Process in Corporate Accounting: The steps involved in corporate accounting are: 1.  The first step in corporate accounting is to record all financial transactions of the company, including sales, purchases, expenses, and payments. This involves maintaining various books of accounts such as a cash book, journal, and ledger. 2.  Once the transactions have been recorded, the next step is to classify them into different categories, such as revenue, expenses, assets, liabilities, and equity. This involves assigning proper accounting codes and ensuring that the transactions are recorded in the correct accounts.

11. 3.  After the transactions have been recorded and classified, the next step is to summarizes them into financial statements. The key financial statements include the balance sheet, income statement, and cash flow statement. 4.  Once the financial statements have been prepared, the next step is to analyze them to gain insights into the company's financial performance, liquidity, and solvency. This involves comparing the current year's financial data with previous years' data and industry benchmarks. 5.  The final step in corporate accounting is to interpret the financial data and provide insights to management, stakeholders, and investors.

12. This involves identifying areas of strength and weakness and making recommendations to improve performance and profitability. Overall,  corporate accounting  is a complex process that involves multiple steps, from recording transactions to interpreting financial data. The objective is to provide accurate and timely financial information that helps management make informed decisions and comply with statutory and regulatory requirements.

13. Financial Statement Analysis Financial Statement Analysis refers to the process of reviewing and analyzing a company’s financial statements. It is primarily done to make better financial decisions and devise plans for the company to earn more income in the future.  The term ‘Financial Statement Analysis’ refers to the systematic numerical representation of the relationship of one financial aspect with the other. The activity of financial statement analysis is undertaken to analyse the company on the basis of its profitability, solvency, operational efficiency, and growth prospects.

14. Financial Analysis chiefly involves bifurcating the financial records on the basis of a definite plan, arranging them in sections, and presenting them in a user-friendly manner. Purpose of Financial Statement Analysis Following is the list of purpose of financial statement analysis: To measure the financial standing of the business To evaluate the profitability (earning capacity) of the business To make comparisons within the firm (intra-firm) and with other firms (inter-firm)

15. To find out the business’ capability of paying interest, dividend, etc. To judge the performance of the management To measure the firm’s short-term and long-term solvency Types of Financial Analysis The main types of financial statement analysis are as follows:

16. Types of Financial Analysis The main types of financial statement analysis are as follows: Types Meaning Horizontal Analysis It refers to the analysis of financial statement figures that are dynamic in nature. It compares one item with another in a different time period. It analyses the business’s finances from one year to the next. Vertical Analysis The relationship between various items on a financial statement is analyzed . For instance, one item is measured against another during an accounting period. The relationship is expressed in percentage.

17. Liquidity Analysis It uses ratios to determine whether or not a company will be able to pay back any debts or other expenses. It is helpful for businesses as they can predict financial troubles in future. This analysis is helpful for lenders, creditors, etc. who want some insight into the business’ financial standing before giving them any loans or credit. Profitability Analysis In this, the company’s rate of return is analyzed . As every business seeks profits, using the profitability analysis to measure its cost and revenue over a given period can be highly beneficial. A company is considered profitable if its revenue exceeds the costs. Margin Ratios and return Ratios are the two main types of profitability analysis.

18. Variance Analysis It refers to the process of evaluating any differences between a business’ budget and the actual costs incurred. For instance, if a business budgeted their sales of INR 10,000 but actually sold goods worth INR 4,500, then the variance analysis would be with a difference of INR 5,500 Valuation Analysis It analyzes the business’ present value and can be utilized for various instances such as mergers and acquisitions. Once the company’s present ratios are determined, they can be compared to the past ratios, competitor’s ratios, etc. There are different types of valuation ratios such as price/ earnings and price sales.

19. Scenario and Sensitivity Analysis The value of an investment is measured based on the current scenarios and changes. Scenario and sensitivity analysis is helpful to predict outcomes based on different variables.

20. Importance or Uses of Financial Statement Analysis There are various uses of financial statement analysis for different users like investors, creditors, management, government, and so on, mentioned as below: Users Areas of Interest For Management To know the company’s profitability, liquidity, and solvency. To measure the effectiveness of the decisions taken and to take corrective actions ahead.

21. For Investors To know the business’ earning capacity and its future growth prospects and evaluate the safety of their investment and a reliable return. For Creditors To know the liquidity and solvency position of the business. For Government To know the profitability position required for taxation purposes and to take decisions about price regulations.

22. For Customers To know about the longevity of the business. For Employees To know about the progress of the company for evaluating bonus, increase in wages, job stability, etc.

23. Tools of Financial Statement Analysis The various tools of financial statement analysis help in evaluating and interpreting the company’s financial statements for planning, investment, and performance. The most commonly used tools of financial analysis are comparative statement (comparison of financial statements), common size statement (vertical analysis), ratio analysis (quantitative analysis), cash flow analysis, and trend analysis.

24. Funds Flow Statement

25. Introduction: Balance Sheet and Profit and Loss Account are the two important financial statements which are prepared at the end of the financial year. Balance Sheet shows financial position of an undertaking, i.e., assets and liabilities, as on a particular date. The profit and loss account shows the result of operations, i.e., profit or loss during the financial year. No doubt, these two financial statements reveal very useful information. But these two statements have a serious limitation, i.e., they fail to reveal the changes in assets and liabilities during the financial year. In the course of business operations, various assets, liabilities and capital undergo

26. Various changes during the financial year. The knowledge of such changes and reasons of these changes is extremely useful to management of the company. For example, A company may have issued debentures to raise funds for the purchase of plant and machinery. But this information is not revealed by Balance Sheet. Therefore an additional statement should be prepared to show the changes in assets, liabilities and owner’s equity between dates of two Balance Sheets. Such a statement is known as “Statement of Changes in Financial Position.” this statement summarises the following.

27. (a) Changes in assets, liabilities and owner’s equity, resulting from financial and investment transactions during the period; and (b) Various ways in which the financial resources of the company have been during the period, e.g., to purchase fixed assets, like plant and machinery, furniture etc.; to redeem debentures, to pay dividends to shareholders and so on. The statement of Changes in Financial Position may be prepared on: ( i ) Net working capital basis, i.e., Funds Flow Statement; or (ii) Cash basis, i.e., Cash Flow Statement.

28. Meaning of Funds Flow Statement: The fund flow statement is an attempt to report the flow of funds between various assets and liabilities and owner’s capital during an accounting period. In the words of Smith and Brown, ‘Funds Flow Statement is prepared to indicate in summary form, changes occurring in items of financial position between two different balance sheet dates.’ Such a statement is prepared to indicate the increases and utilization of resources of a business during an accounting period. A Funds Flow Statement is also known by various other names such as ‘ Statement of Sources and Application of Funds’. Where Got, Where Gone Statement’, Statement of Funds Generated and Expended’, etc.

29. Meaning of Fund: The term ‘Funds’ has different meanings. However, for the purpose of funds flow statement, the term ‘funds’ means ‘Net Working Capital’ also known as ‘Net Current Assets’. It is defined as the difference between current assets and current liabilities. Thus: Fund = Current Assets – Current Liabilities Note: Provisions against current assets, provision for bad doubtful debts, etc., are also treated as current liabilities, because such provisions reduce the amount of current assets.

30. What is Flow of Fund? Taking ‘fund’ in the sense of ‘net working capital’ flow of fund arises when the net effect of a transaction is to increase or decrease the amount of working capital. When a transaction results in the increase of fund, such a transaction is said to be a source of fund. On the other hand, if a transaction results in the decrease of fund, such a transaction is said to be an application of fund. A transaction that does not result in either increase or decrease of fund does not result in the flow of funds.

31. How to Judge Whether a Transaction Results in Flow of Fund or Not? In order to judge as to whether a particular transaction has resulted in the change in the net working capital, a journal entry should be made and the accounts involved should be classified into current and non-current. If all the accounts involved in the transaction belong to current category , then there is no flow of funds. Similarly, if all the accounts involved in the transaction belong to non-current category, then also there is no flow of funds. However, a transaction will result in the flow of fund only when one of the accounts involved in the journal entry belong to current category and another to non-current category.

32. On the basis of the above description, the concept of flow of fund can be summarized below: Category 1: when a transaction involves only current accounts, there is no flow of funds. Category 2: when a transaction involves only non-current accounts, there also there is no flow of funds. Category 3: when a transaction involves a current account and non-current account, the net working capital increses or decreases and then there is flow of funds.

33. Other Transactions Indirectly Affecting Funds There are certain accounts of revenue nature which do not belong to any of the current or non-current category, e.g., Rent paid, insurance premium paid, etc. in the case of such transactions, like any other account of a revenue nature, these are transferred to profit and loss account. For example, wages, salaries, rent and commission, are transferred to profit and loss account. Thereafter, a consolidated entry is made to judge as to whether the transaction has resulted in the flow of funds or not.

34. Example: 1. Wages paid: Journal entries are: (a) Wages Account Dr. To, Cash Account (b) Profit and Loss Account Dr. To, Wages Account The consolidated entry will be: (c) Profit and Loss Account (Non-current A/c) Dr. To, Cash Account (Current A/c) Conclusion – Thus this transaction results in the flow of funds because one A/c belongs to non-current A/c category and other to Current A/c category.

35. 2. Depreciation provided on fixed assets: Journal entries are: (a) Depreciation A/c Dr. To, Fixed Asset A/c (b) Profit and Loss A/c Dr. To, Depreciation A/c (c) Profit and Loss A/c (Non- Current A/c) Dr. To, Fixed Asset A/c (Non- Current A/c) Conclusion – As both the accounts involved belong to non-current A/c category, the transaction does not result in the flow of funds.

36. Hidden Transactions There are certain transactions which are not apparent and are hidden. Such transactions have to be located in order to know their effect on the funds. In such circumstances, the relevant account should be prepared to find out the hidden information.

37. Preparation of Funds Flow Statement In order to prepare a funds flow statement, it is necessary to find out the various ‘Sources’ and ‘Applications’ of funds. Particulars Amount Sources of Fund: Issue of Share Capital Issue of Debentures Loan from Institutions Sale of non-current assets and investments Funds from operations (Profit) Total Sources Applications: Redemption of Preference Shares Redemption of Debentures Repayment of Loans Purchase of Non-current Assets Loss from operation (Loss) Payment of dividend, taxes, etc. Total Application Net Increase /Decrease in W/C (Total Sources – Total Applications)

38. Alternatively, the funds flow statement may be prepared in T-form account as follows: Sources of Funds Amount Application of Funds Amount Issue of Share Capital Issue of Debentures Loan from Institutions Sale of non-current assets and investments Funds from operations (Profit) Decrease in working capital (B.F.) Redemption of Preference Shares Redemption of Debentures Repayment of Loans Purchase of Non-current Assets Loss from operation (Loss) Payment of dividend, taxes, etc. Increase in working capital(B.F)

39. The generalization can be put in the form of an equation as follows: 1. Sources = Application or Uses 2. (Increase in Equities + Decrease in Assets) = (Increase in Assets + Decrease in Equities) This relationship can also be explained in terms of debits and credits. Increases in equities and decreases in assets are both credits; increases in assets and decreases in equities are both debits. Thus the above equation follows from the fact that changes in debits must equal to changes in credits.

40. Statement of Changes in Working Capital The statement of Sources and Application of funds show a the difference between the aggregate of sources and total applications as either increase or decrease in working capital. This variation in working capital can be verified by preparing a statement of changes in working capital. This statement, unlike statement of sources and applications, is prepared with the help of only current assets and current liabilities. It should be remembered that such a statement is prepared only from the information given in the balance sheets and there is no effect on this statement of any additional information supplied outside the balance sheet.

41. A pro forma of a statement of changes in working capital is given below: Particulars Previous year Current Year Effect on working capital Rs. Rs. Increase (+)Rs. Decrease (-) Rs. Current Assets: Cash and Bank Debtors Stock Prepaid Expenses Bills Receivable, etc. Total Current Liabilities: Creditors Bills Payable Outstanding Expenses Total Increase or Decrease in working capital

42. While preparing the statement it should be noted that: (a) Increases in current assets result in increase (+) in working capital (b) Decreases in current assets result in decrease (-) in working capital (c) Increases in current liabilities result in decrease (-) in working capital (d) Decreases in current liabilities result in increase (+) in working capital

43. Items Requiring Special Attention: Given below are certain items which requires special attention while preparing a statement of sources and application of funds. 1. Funds from operations Profit is a very important sources of funds in a business. In fact, profit from operations is the only item of source which is generated by the internal sources, i.e., by the operations of business activities. However, it is important to note that net profit as shown by the profit and loss account does not always correctly represent the amount of fund from business operations. The reason is simple. There are certain items

44. which appear in the profit and loss account but do not involve any payment in cash, e.g., depreciation, writing off goodwill and preliminary expenses, etc. these types of items do not have any effect on working capital and are termed as ‘non-fund’ items. The net profit as shown by the profit and loss account has to be adjusted for these ‘non fund’ items so as to arrive at the real fund from operations. The following are the main adjustments:

45. Add: Generally the following items are added back to net profit (NON-CASH ITEMS): Depreciation on fixed assets. Written off fictitious and intangible items, like goodwill, preliminary expenses, discount on issue of shares, etc. Loss on sale of fixed assets- this item is added back to net profit because the net proceeds from the sale of fixed assets is shown as a source of funds in the funds flow statement as a separate item. Appropriation of profit – items like transfer to general reserve and sinking fund are appropriations of profit and are thus added back to the profit to determine the fund from operations. But if these items appear in the profit and loss appropriation account and profit before appropriation is being considered, these items are not added back to profit. Dividend on shares is also an appropriation of profit and is thus added back to profit if dividend is shown before ascertaining profit.

46. Deduct : The following items are deducted from net profit as they do not result increase of funds (NON OPERATING INCOMES): Profit on the sale of fixed assets: This item is deducted from net profit because total amount realized from the sale of fixed assets is shown as a source of fund in the funds flow statement as separate item. Profit on revaluation of fixed assets. This item is deducted from net profit because that is a non-cash item. Non-operating incomes, such as dividend and interest received, rental income, refund of taxes, etc. are deducted from net profit because such items are separately shown as sources of fund in the funds flow statement.

47. There are two methods of computing fund from operations. In the first method, we start with net profit and then add and deduct items as described above so as to arrive at funds from operations. In the second method, we start with sales figure which is the main source of fund. From this sales figure all such expenses are deducted which are uses or applications of fund. Both of these methods give the same amount of fund from operations.

48. Determination Of Funds From Operations In Case Of Net Loss: If profit and loss account shows a net loss, it does not necessarily mean that there is loss from operations. If the ‘non-fund’ items on the debit side of profit and loss account exceed the aggregate of net loss and ‘non-fund’ items appearing in the credit side of profit and loss account, the difference would represent funds from operations and vice versa. Calculation of funds from operations Funds from operations may be computed by preparing a statement by starting with the net profit already calculated and then add and deduct items to arrive at funds from operations. Alternatively, funds from operations may be calculating by preparing adjusted profit and loss account in T-form as shown below:

49. Pro forma of adjusted profit and loss account Particulars Amount Particulars Amount To, Non-fund items: Depreciation Depletion Loss on sale of fixed assets Premium on redemption of debentures/pref. shares Discount on issue of shares and debentures Goodwill written off Patents written off Preliminary expenses written off Appropriation of profits: General Reserve Debenture sinking fund Proposed dividend Interim dividend Taxation Provision Debenture sinking fund Net profit C/d By, Net profit b/d By, Non-operating incomes: Interest received Dividend received Refund of taxes Profit on sale of non-current assets By, Funds from operations (Balancing figure)

50. Treatment of Provision for taxation Provision for taxation may be treated in either of the following two ways while preparing a funds flow statement. As a current liability: When provision for taxation is treated as a current liability, it appears in Statement of Changes in Working Capital. In such a case it will not be taken into account for calculating funds from operations and nothing appears on applications side of the Funds Flow Statement on account of taxation. As a non-current liability: When provision for taxation is treated as a non-current liability, provision created during the year is added back in profit to calculate funds from operations and tax paid during the year is shown as an application of fund in the Funds Flow Statement. In this case does not appear in the Statement of Changes in Working Capital.

51. Treatment of Proposed Dividend: This item may be treated either of the two ways, as stated below: As a current liability: In such a situation, it appears in the statement of changes in working capital and no adjustment is made in the calculation of funds from operations. It is also not recorded in the Funds Flow Statement as an application. As a non-current liability: When proposed dividend is treated as a non-current liability, it is added back in profit to calculate funds from operations and dividend actually paid (or payable) is shown as an application of fund in the Funds Flow Statement. In does not appear in the Statement of Changes in Working Capital.

52. Treatment of Interim Dividend: Interim dividend paid is shown as an application of fund in the Funds Flow Statement. It is also added back in the net profit for calculating the funds from operations, if it has already been debited to profit and loss account.

53. Meaning of Cash Flow Statement

54. The cash flow statement is being prepared on the basis of extracted information of historical records of the enterprise. Cash flow statements can be prepared for a year, for six months, for quarterly and even for monthly. The cash includes not only means that cash in hand but also cash at bank. Objectives of Cash Flow Statements The following are the main motives of preparing the cash flow statement: To identify the causes for the cash balance changes in between two different time periods, with the help of corresponding two different balance sheets. To enlist the factors of influence on the reduction of cash balance as well as to indicate the reasons though the profit is earned during the year and vice versa.

55. In view of the significant contribution of the statement of cash flows, the Institute of Chartered Accountants of India has issued in March, 1997 Accounting Standard-3 (Revised) (AS-3 Revised) ‘Cash Flow Statements’ in suppression of Accounting Standard-3 “Changes in Financial Position” issued in June 1981. It is in tune with the trends in other countries where cash flow statement has replaced the “Statement of Changes in Financial Position”. As such cash flow statement should be prepared in line with the stipulations given in AS-3 (Revised). According to the revised Accounting Standard-3, an organisation should prepare a cash flow statement and should present it for each period.

56. Meaning of certain terms used in this context: Cash: Cash comprises cash in hand and demand deposits with banks. Demand deposits mean those deposits which are repayable by bank on demand by the depositor. Cash equivalents: Cash equivalents are short term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value. Cash equivalents are held for the purpose of meeting short term cash commitments rather than for investments or other purposes. Examples of cash equivalents are treasury bills, commercial paper etc.

57. Investments in shares are excluded from cash equivalents unless they are in substance cash equivalents, for example preference shares of a company acquired shortly before their specified redemption date (provided there is only an insignificant risk of failure of the company to repay the amount at maturity). Cash flows: Cash flows are inflows and outflows of cash and cash equivalents. It means the movement of cash into the organisation and movement of cash out of the organisation. The difference between the cash inflows and outflows is known as net cash flow which can be either net cash inflow or net cash outflow.

58. Cash flows exclude movements between items that constitute cash or cash equivalents because these components are part of the cash management of an enterprise rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash in cash equivalents.

59. CLASSIFICATION OF CASH FLOWS STATEMENT The cash flow statement during a period is classified into three main categories of cash inflows and cash outflows i.e. operating, investing and financing activities. ( i ) Cash Flows from Operating Activities Operating activities are the principal revenue-producing activities of the enterprise . Operating activities include cash effects of those transactions and events that enter into the determination of net profit or loss. A business’s normal operations result in both cash receipts and cash payments. Cash receipts result from selling goods and providing services.

60. The cost of goods sold and other operative expenses result in cash disbursements. The revenues and expenses reported in the income statement, however, do not coincide with the cash receipts and payments as we prepare the income statement on an accrual basis. The receipts and payments of cash for these revenues and expenses may occur in either an earlier or later period than the period we report the revenues and expenses. Following are examples of cash flows from operating activities: (a) cash receipts from the sale of goods and the rendering of services; (b) cash receipts from royalties, fees, commissions, and other revenues; (c) cash payments to suppliers for goods and services; (d) cash payments to and on behalf of employees;

61. (e) cash receipts and payments of an insurance enterprise for premiums and claims, annuities and other policy benefits; (f) cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and (g) cash receipts and payments relating to future contracts, forward contracts, option contracts, and swap contracts when the contracts are held for dealing or trading purposes.

62. (ii) Cash Flows from Investing Activities Investing activities are the acquisition and disposal of long term assets and other investments not included in cash equivalents. In other words, investing activities include transactions and events that involve the purchase and sale of long-term productive assets (e.g. land, building, plant and machinery etc.) not held for resale and other investments. The following are examples of cash flows arising from investing activities: (a) cash payments to acquire fixed assets (including intangibles). These payments include those relating to capitalised research and development costs and self-constructed fixed assets;

63. (b) cash receipts from disposal of fixed assets (including intangibles); (c) cash payments to acquire shares, warrants, or debt instruments of other enterprises and interests in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes); (d) cash receipts from disposal of shares, warrants, or debt instruments of other enterprises and interests in joint ventures (other than receipts from those instruments considered to be cash equivalents and those held for dealing or trading purposes);

64. (e) cash advances and loans made to third parties (other than advances and loans made by a financial enterprise); (f) cash receipts from the repayment of advances and loans made to third parties (other than advances and loans of a financial enterprise); (g) cash receipts and payments relating to future contracts, forward contracts, option contracts, and swap contracts except when the contracts are held for dealing or trading purposes, or the transactions are classified as financing activities.

65. (iii) Cash Flows from Financing Activities Financing activities are activities that result in changes in the size and composition of the owners’ capital (including preference share capital in the case of a company) and borrowings of the enterprise. Following are the examples of cash flows arising from financing activities: (a) cash proceeds from issuing shares or other similar instruments; (b) cash proceeds from issuing debentures, loans notes, bonds and other short term borrowing. (c) cash repayments of amounts borrowed i.e. redemption of debentures, bonds etc. (d) cash payments to redeem preference shares. (e) payment of dividend.

66. Treatment of Other Items Besides the above cash flow activities AS-3 (revised) also give the dealing of the some other items. These other items are as follows: Foreign Currency Cash Flow: Unrealized gain or loss on account of change in the foreign exchange rate is not treated as cash flow. But the effect of change of foreign exchange on the cash and cash equivalents held in a foreign currency is recorded in the cash flow statement to reconcile the cash and cash equivalents at the beginning and at the end of the period. This amount is not adjusted with operating, investing and financing activities but it is shown separately.

67. Extra-ordinary Items: Cash flow arising from the extra-ordinary item is shown in the cash flow statement after classifying it into operating, investing and financing activities. This is done so that ordinary users may understand them easily. For example, loss by fire in store is compensated by insurance company. It will be treated as cash flow from operating activities. Taxes on Income: If no adverse information is given relating to taxes paid on incomes, cash flow arising from the taxes paid as income is classified in operating activities. If taxes are paid on such income which is relating to finance, such a cash flow will be classified into financial activities.

68. Interest and Dividends: If a financial enterprise is receiving interest and dividend then such a cash flow arising from interest and dividend will be considered into operating activities. If interest and dividend are received by other enterprise, such a cash flow arising from interest and dividend will be considered into investing activities and if interest and dividend is paid, such a cash flow arising from interest and dividend is considered into financing activities. This cash flow arising from interest and dividend paid or received is disclosed separately. Balances of Foreign Branches: In some situations, the balance of cash and cash equivalent held with foreign branches are not available due to foreign exchange control or other legal restrictions. So the management should use that amount which can be measured in cash and cash equivalent.

69. Non-cash Transactions: The non-cash transactions are not recorded in cash flow statement because they do not have a direct impact on the current cash flow while they affect the capital and assets as purchase of fixed assets by the issue of shares or debentures. In AS-3 (revised) examples of non-cash transactions are mentioned as below: the acquisition of assets by assuming directly related liabilities, the acquisition of an enterprise by means of issue of shares, and the conversion of debt to equity.

70. Preparation of Cash Flow Statement Cash flow statement provides information about the cash receipts and payments of an enterprises for a given period. It provides important information that supplements the profit and loss account and balance sheet. The statement of cash flows is required to be reported by Accounting Standard-3 (Revised ) issued by the Institute of Chartered Accountants of India in March 1997 Which replaces the ‘Changes in Financial Position’ as per AS-3. There are certain changes in the preparation of cash flow statement from the previous methods as a result of the introduction of AS-3 (Revised).

71. AS-3 (Revised) is mandatory in nature in respect of accounting periods commencing on or after 1-4-2001 for the following: 1. Enterprises whose equity or debt securities are listed on a recognised stock exchange in India, and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognised stock exchange in India as evidenced by the board of directors’ resolution in this regard. 2. All other commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds ` 50 crores. There are two methods of converting net profit into net cash flows from operating activities: ( i ) Direct method, and (ii) Indirect method.

72. Direct Method Under direct method, cash receipts from operating revenues and cash payments for operating expenses are arranged and presented in the cash flow statement. The difference between cash receipts and cash payments is the net cash flow from operating activities. It is in effect a cash basis profit & loss account. In this case, each cash transaction is analysed separately and the total cash receipts and payments for the period are determined. The summarised data for revenue and expenses can be obtained from the financial statements and additional information. We may convert accrual basis of revenue and expenses to equivalent cash receipts and payments. Make sure that a uniform procedure is adopted for converting accrual base items to cash base items.

73. The following are some examples of usual cash receipts and cash payments resulting from operating activities: 1. Cash sales of goods and services; 2. Cash collected from debtors (customers); 3. Cash receipts of interest or dividends; 4. Cash receipts of royalties, fees, commission and other revenues; 5. Cash payments to suppliers (creditors); Cash payments for various operating expenses, i.e., rent, rates, power, etc. Cash payments for wages and salaries to employees; Cash payments for income tax, etc.

74. Indirect Method In this method, the net profit (loss) is used as the base and converted to net cash provided by (used in) operating activities. The indirect method adjusts net profit for items that affected net profit but did not affect cash. Non-cash and non-operating charges in the profit & loss account are added back to the net profit, while non-cash and non-operating credits are deducted to calculate operating profit before working capital changes. It is a partial conversion of accrual basis profit to cash basis profit. Necessary adjustment are made for increase/decrease in current assets and current liabilities to obtain net cash from operating activities.