8.1 – Brief Description

The cash flow statement of a company is a very important financial statement. This shows how much cash the company is generating. You may ask whether this information does not appear in the P&L statement, the answer is yes or no.

Let us consider the example of a coffee shop, where transactions are done in cash. If you want coffee or something to eat, then you should have that much money. Suppose on any one-day coffee worth Rs 2500 and food items worth Rs 3000 were sold in this coffee shop.   

This means that the company earned ₹5500 on that day. This ₹5500 will appear as income in the P&L of the company. There will be no room for doubt in this.

Now let’s take another example. Suppose there is a shop that sells laptops. Let’s assume that this shop sells only one type of laptop, which costs ₹ 25000. Suppose 20 laptops were sold at this shop on any one day i.e. a total of ₹ 500000 was earned, but what would happen if five of these laptops were sold on credit? Sale on credit means that the customer takes the goods to his home and pays the money later in a lump sum or in installments. What would this sales figure look like now? 

Cash sales: 15 × 25000 = Rs.375,000

Credit sales: 5 × 25000 = Rs.125,000 

Net Sales: Rs.500,000

In the P&L statement of this shop, you will see a net profit of ₹500,000, which is nice to see. But how much of this ₹500,000 will be cash in the company’s bank account is unclear if the company has a loan of ₹400,000, which it has to pay off immediately. The company will not be able to do this as it has only ₹375,000 in its bank account although it has made sales of ₹500,000. This means that the company will not be able to meet its liabilities because it does not have enough cash.

Such information is available only in the cash flow statement. That is why the cash flow statement of the company is considered important and should be looked at carefully as the financial statement of any company because only then you will know the cash or cash position of the company.

Keep in mind that the financial condition of the company is not known only by its profit, but it is also necessary to see how much cash or cash the company has and how is the cash flow of the company. This is a better way to know the condition of the company.

8.2 – Activities of the company

Before we understand the cash flow further, it is important to know the types of things that happen in the functioning of the company. If you think carefully, you will see that the business of the company can be divided into three main parts. Let us understand with an example

Suppose there is a company that runs a fitness center. What do you think, what kind of work is done there? I make a list of its functions.

1. advertising to attract new customers  
2. Hiring a Fitness Trainer to Serve Clients 
3. Replacing old fitness machines with new fitness machines 
4. Taking a short-term loan from the bank for this purpose 
5. and issue certain certificates of deposit to raise money 
6. Issuing more shares to some friends to raise money 
7. Investing money in some new startup companies trying to bring new innovations 
8. Keeping the remaining money in a fixed deposit 
9. investing in a building in a new area to open a fitness center there 
10. and installing a new sound system in the fitness center 

You can see that all this is work related to his business. But these are very different kinds of things.

We can divide them into three parts:

Operational activities (OA) means business work: This is the work that is related to the main business or business of every day. This is called operational activity. This includes sales ie sales, marketing, manufacturing ie production, technology, and resource hiring ie bringing people or machines to work, etc. 

Investing activities (IA): This includes work that a company does with the intention that it will benefit from it later. Such as investing to earn interest, investing in land or property, investing in machines, intangible assets, or non-current assets.

Financing activities (FA): This includes things a company does financially, such as paying dividends, paying interest on debt, raising new debt, or issuing corporate bonds.

The functioning of any good company can be divided into these three parts.

On the basis of these three parts we divide the functioning of the company mentioned earlier.

1. OA Advertising to Attract New Customers  
2. Hiring a fitness trainer to serve customers OA
3. OA to replace old machines with new fitness machines
4. Taking a short-term loan from the bank for this purpose FA
5. Issuance of certain Certificates of Deposit to raise more money FA
6. FA issuing more shares to some friends to raise money 
7. Investing in some new startup companies trying to bring new innovations
8. Keep the remaining money in a fixed deposit IA
9. Investing money in a building in a new area so that a fitness center can be opened there.
10. and installing a new sound system in the fitness center.

Now think that whatever work the company is doing will affect the cash position of the company because either cash will be going out or cash will be coming in. Everything a company does has an impact on its cash position. For example, if the company has to buy sound equipment, then the company will have to pay money for this and its cash position or cash balance will be less. Also, this sound system will act as an asset for the company.

With this in perspective, let us look at the above example again and understand how each transaction affects the cash balance and balance sheet. 

Number	Activity Type	Need	cash balance	in the balance sheet
01	OA	advertising spend	will reduce	Is an  asset, adds to the brand value of the company
02	OA	new hiring costs	will happen	Is an  asset, adds intellectual value to the company
03	OA	expenditure on new machines	will happen	is an  asset
04	FA	Loan means cash will come into the business	will grow	debt ie  liability
05	FA	Deposit through CD means cash will come	will grow	CD means liability
06	FA	Cash will come from issuing new capital	will grow	An increase in share capital means liability
07	IA	Cash will go by invested money in startup companies	will happen	investment  is an asset
08	IA	Putting money in FD will result in cash	will happen	Cash is just like an investment so it is  an asset
09	IA	Investment in building means cash will go from business	will happen	Gross block  is an asset
10	OA	sound system cost	will happen	is an  asset

In the table above, we have color-coded them:

1. increasing cash means blue color 
2. Cash decrease means red color 
3. The green color is for the asset 
4. Adding liability means purple color

If you look at the above table in terms of cash balance and asset/liability relationship, you will find that: 

1. Whenever the liability of the company increases, the cash balance of the company also increases.
   1. It also means that when the company incurs a liability, the cash balance also decreases.

2. The cash balance decreases whenever the company’s assets increase.
   1. Cash balance increases when assets decrease

These findings are the most important principles for preparing the cash flow statement. It is also worth noting that every activity of the company, be it operating activity, finance activity, or investing activity, either increases or decreases the cash of the company.

In this way, now the cash flow of the company will be added like this.

Company’s Cash Flow = Net Cash Flow from Operating Activities + Net Cash Flow from Investing Activities + Net Cash Flow from Financing Activities   

8.3 – Cash Flow Statement

After knowing these important things about the Cash Flow Statement, you will now be able to understand the Cash Flow Statement in a better way.

When any company prepares its cash flow statement, that statement is divided into three parts. So that it can be clearly seen how much cash the company has made or spent within the three functions mentioned above. On this basis, let us now look at the cash flow statement of ARBL.

I have omitted several line items here because there is no need to explain them. But note here that ARBL has raised 278.7 crores from operating activity. The thing to remember is that if any company has positive cash flow from its core business i.e. operating activities, then it tells that the company is doing well.

Here you can view the Cash Flows from the Operating Activities of ARBL.

As you can see, ARBL has spent Rs 344.8 crore in investing activity. You must have understood that due to this the cash with the company has decreased. Also, it is also worth noting that if the company is making good investments, then it clearly means that the company wants to grow its business in the future. But we will understand further whether the company has made a good investment or a bad one.

Now let us look at the cash balance of the financing activities of ARBL. 

You can see that ARBL has spent Rs 53.1 crore under financing activity. Most of this cash has been spent on paying dividends. If the company takes on more debt in the future, it will increase the cash balance of the company (an increase in liability increases the cash balance). But we know from the balance sheet of ARBL that the company has not taken any new loans. 

Let us once again look at the cash flow statement under all three activities.

whose cash flow	Rs.crore (2013-14)	Rs.crore (2012-13)
operating activities	278.7	335.4
investing activities	(344.8)	(120.05)
financing activities	(53.1)	(34.96)
gross	(119.19)	179.986

This means that the company spent Rs 119.19 crore in the financial year 2013-14. But what happened to last year’s cash? As you can see the company generated cash of Rs 179.986 crore last year. Let us once again look at the cash flow statement of ARBL.

Look at the part highlighted in green. It is told here that the opening balance of this year (2013-14) is Rs 409.46 crore, where did this amount come from? This is actually the closing balance of the previous year (shown by the arrow). When this year’s cash figure is added which is 119.19 crores and a foreign currency exchange of 2.58 crores is added to this, we get the total cash position of the company which is 292.86 crores. This shows that the company has spent a lot of cash annually but still the company has a lot of cash due to the previous year’s cash.

Remember that the closing balance of 2013-14 will now be the opening balance of 2014-15. You should see this amount when you look at ARBL’s figures as on March 31, 2015.

Now let us look at some questions and their answers.

1. What does the figure of Rs 292.8.6 crore tell us?
   • It tells how much cash with ARBL is currently lying in the company’s bank account.
2. What is cash?
   • It refers to the cash held by the company or kept in-demand deposits. These are the liquid assets of the company.
3. What are liquid assets?
   • These are those assets that can be easily converted into cash or cash equivalent.
4. Can we treat liquid assets as current items which are shown in the balance sheet?
   • You can view these as current items.
5. If cash is current and cash is an asset, should it be shown under current assets in the balance sheet?
   • Correct. It is a current asset and it is visible right there. Let’s take a look at the balance sheet. 

From this, we can conclude that there is a relationship between the cash flow statement and the balance sheet. We discussed earlier that all three financial statements are interrelated. 

8.4 Financial Statements in Summary

In the last few chapters, we have discussed the 3 most important financial statements of the company namely the P&L Statement, Balance Sheet, and Cash Flow Statement. The cash flow statement and P&L statement are prepared on a standalone basis while the balance sheet is prepared on a flow basis.

How much the company earned, how much it earned, and how much it spent are discussed in the P&L statement. After spending the money (surplus or retained income) of the company’s income, the company takes it forward in its balance sheet. The P&L statement also contains the depreciation figures of the company and the depreciation figures are carried forward from the P&L statement to the balance sheet. 

A balance sheet shows the assets and liabilities of the company. Company shareholders’ funds are also shown in the assets portion of the balance sheet. Assets should always be equal to liabilities, only then the balance sheet is considered balanced. An important piece of information in any balance sheet is how much cash or cash equivalents a company has. This shows how much money is in the company’s bank account. This figure comes from the company’s cash flow statement.

The cash flow statement describes a company’s ability to generate cash or cash equivalents. Also, it is also told how much cash the company will need. In this, old historical data is also taken. This means that the figures of the previous year are also put in it and all the information is given about cash or cash equivalents from the point of view of operating, investing, and financing activities. It is also told that how much money is there in the bank account of the company.

So far we have learned how to read the financial statements of the company, what information it contains, and what we should look for in them. But we haven’t learned yet how to analyze these data. One way to analyze these is to look at some important financial ratios. We will look at financial ratios in the next few chapters.

Main points of this chapter

1. The cash flow statement gives us information about the cash position of the company 
2. The work of any good company can be divided into three parts- Operating Activities (Business Work), Investing Activities (Investment Work), Financing Activities (Financial Work) 
3. Money is spent or money is earned by any kind of work. 
4. The company’s net cash flow is made by combining cash flow from all three functions, operating, investing, and financing. 
5. Any investor should carefully look at the cash flow of the operating activity of the company.
6. When the liability of the company increases, the cash increases, and if the liability decreases the cash decreases. 
7. When assets increase, cash decreases; when assets decrease, cash increases.
8. You can also see the company’s net cash flow in the balance sheet.
9. A cash flow statement is a financial statement describing the true state of business of a company.