Cash Flow Classification and Bank Overdraft
The accountant of Kiran Ltd has prepared the following data for the year ended 31 March 2024: profit before tax ₹8,00,000; depreciation ₹1,20,000; gain on sale of machinery ₹40,000 (book value ₹1,60,000; sale proceeds ₹2,00,000); interest on borrowings ₹60,000; interest on investments ₹20,000; tax paid ₹1,80,000; dividend paid ₹1,00,000. Trade receivables increased by ₹80,000; inventory decreased by ₹50,000; trade payables increased by ₹30,000; prepaid expenses increased by ₹10,000; outstanding expenses decreased by ₹5,000. Investments were purchased for ₹1,50,000 and borrowings repaid ₹1,00,000. The bank overdraft increased by ₹40,000. The accountant classified interest paid as operating, interest received as operating, and the bank overdraft movement as financing. The draft cash flow shows a net increase of ₹5,75,000. The directors want to know whether the classification is correct and why the cash flow does not match the profit.
1. Compute cash flows from operating, investing and financing activities using the accountant’s classification. Show the adjustment for each item.
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Operating: PBT ₹8,00,000 + depreciation ₹1,20,000 − gain ₹40,000 + interest on borrowings ₹60,000 − interest on investments ₹20,000 = ₹9,20,000. Working-capital adjustment: −₹80,000 + ₹50,000 + ₹30,000 − ₹10,000 − ₹5,000 = −₹15,000. Cash generated = ₹9,05,000; tax paid ₹1,80,000; operating = ₹7,25,000.
Investing: sale of machinery ₹2,00,000 − purchase of investments ₹1,50,000 + interest received ₹20,000 = ₹70,000.
Financing: interest paid ₹60,000 − borrowings repaid ₹1,00,000 − dividends ₹1,00,000 + increase in overdraft ₹40,000 = −₹2,20,000.
Net = 7,25,000 + 70,000 − 2,20,000 = ₹5,75,000. The ₹40,000 overdraft is treated as a financing inflow under the accountant’s classification.
2. The overdraft is repayable on demand and is integral to cash management. Recompute and explain the effect on financing and on the net increase in cash and cash equivalents.
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Treating the overdraft as a cash equivalent changes only the financing section: financing = −₹60,000 − ₹1,00,000 − ₹1,00,000 = −₹2,60,000. Net cash from activities = 7,25,000 + 70,000 − 2,60,000 = ₹5,35,000. Because the overdraft increased by ₹40,000, cash and cash equivalents (including the overdraft as a negative balance) decrease by ₹40,000: ₹5,35,000 − ₹40,000 = ₹4,95,000. The increase in overdraft is not a financing inflow when it is integral to cash management. If it is not integral, the accountant’s ₹5,75,000 is acceptable.
3. Why is depreciation added back and the gain on sale deducted? Would the sale proceeds also be shown as an investing inflow?
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Depreciation is added back because it reduced profit but did not use cash. The gain on sale is deducted because it increased profit but belongs to investing; only the gain is removed from operating, not the sale proceeds. The sale proceeds of ₹2,00,000 are shown as an investing inflow. Showing the gain again in operating would double count. Interest paid and received are classified by the nature of the company: for a non-financial company, interest paid is financing and interest received is investing, so they are added back or deducted in operating and then shown in the proper section.