Cash Flow Statement
Cash Flow Statement
This domain tests classification of cash flows into operating, investing and financing activities and preparation of a cash flow statement using the indirect method.
Core rules
- Operating activities cover day-to-day revenue and expense transactions; investing activities cover purchase and sale of fixed assets and investments; financing activities cover share capital, debentures, loans and dividends.
- Under the indirect method, start with net profit before tax, add back non-cash expenses such as depreciation, deduct non-operating income and adjust changes in working capital.
- Increase in current assets reduces cash; increase in current liabilities increases cash.
- Tax paid and dividends paid are shown as cash outflows under the appropriate classification.
Worked example
Net profit before tax is Rs.2,00,000; depreciation Rs.30,000; debtors increase Rs.20,000; creditors increase Rs.10,000; tax paid Rs.40,000. Operating cash flow = Rs.2,00,000 + Rs.30,000 - Rs.20,000 + Rs.10,000 - Rs.40,000 = Rs.1,80,000. Depreciation is added because it reduced profit without using cash; the debtors increase uses cash; the creditors increase preserves cash; tax paid is an operating outflow.
Traps
Adding depreciation to investing activities; deducting profit on sale of fixed assets instead of adding it back; treating purchase of fixed assets as operating; and ignoring the effect of an increase in current assets on cash.