Lecture-53- Cash Flow Statement (Part-2)

[Music] [Music] [Applause] [Music] welcome students so uh we are in the process of learning about the cash flow statement I discussed in my previous lecture the importance of the cash flow statement and the requirement of the cash flow statement and as I told you that it has become now a since 1997 after the introduction of as3 accounting standard 3 uh which was developed by the uh Institute of Chartered Accountants of India because in India ICI Institute of Chartered Accountants of India is the body which devops the standards for accounting systems in India so after the

uh say introduction of this standard by International account standard committee on 1st January 2 uh 1st January 1994 uh in India Institute of Chartered Accountants of India accepted this change under as3 under accounting standard 3 and since 1997 in India also this statement has become important this statement has become mandatory and now apart from the income statement and balance sheet the cash flow statement also has to be prepared by the companies and especially by the joint stock companies public limited companies and has to be submitted to the different stakeholders so uh as I was talking

to you in the previous uh lecture that now the change in the new cash flow statement and the as compared to the old cash flow statement is that now the cash flow statement has to be prepared under three broad uh say uh headings or the activities that is operating activities and then investing activities and then the financing activities so that we are easily able to make out that how much cash is flowing in from operations or operating activities how much cash is coming in from investing activities and how much cash is coming in from the

financing activities so that uh the companies who are the manufacturing organizations if they are incurring a loss under the operations and having a profit for investing and financing activities they are exposed they are able to mean they are not able to hide this fact that their operations are but from the other source they are getting the income like videoon and Onida and finally they have the profit so that people maybe the investors lenders or suppliers do not feel disguised so now under this process when this new statement we are going to prepare and learn how

to prepare then we'll find it out that uh what are the activities called as the operating activities what are the activities we should be very clear before learning it because tomorrow if you have to prepare the cash flow statement yourself under as3 then you should be clear that what is the as3 and what is the requirement of as3 and what are the activities called as the operating activities under this standard and uh when we talk about then say operating activities are these activities and we have to consider the cash coming in from these activities as

the cash flow from the operations so you see about this side it is talking about the inflows so this is the inflows of the cash and these are the activities or heads uh on account of which the cash is Flowing out so say for example cash inflow is on account of the cash receives from the sale of goods and rendering of services if it is a manufacturing organization then sale of goods if it is a service rendering organization then any cash is flowing in on the sale of services then yes uh say for example examp

some companies giving the IT services now whatever they are not manufacturing any product so whatever the services they are giving to some say to their clients cash flowing in from those is considered as the cash from operations this is the first activity then cash receives from the royalties fees commission and the other revenues any kind of the say patents company has given technology has given any kind of the say say say copyright the company has given to the other companies it means this is because of their better manufacturing product process somebody else is using that

so for example the drug manufacturing companies now drug manufacturing company spla or Dr Ed or somebody else if they have some good say patents of the drugs and if they have given those drugs rented them out and say other companies are manufacturing the drugs by using those uh patents then in that case that income for the spla or the Dr Ed's lab will be considered as a income from operations similarly cash receives from of an insurance Enterprise for premiums and claims annuities and other policy benefits if it's insurance company then the premium incomes claims or

any kind of the other incomes they are receiving that is which is basically Insurance type of the income and largely their source of income is a premium and then the some annuities say for example some government policies have sold and annually the government is paying them the big amount of the premium say for example from the railways if LC receives the large chunk of Premium from the railways in the form of the annuities that all income is called as the income from operations for the insurance company similarly cash refunds of income tax unless they can

be specifically identified with functioning financing and the investing activities because in India there is a system of the advanced tax payment quarterly tax payments companies do means considering their sales lbel or expected lbel of the sales every quarter the companies pay tax in advance companies not pay tax at the end of the year they make the payment of the Advanced Tax to the government so they keep on paying the tax on the basis of the estimated sales and at the end of the year they calculate that how much total sales are there how much total

profit is there how much tax was due to be paid by that company to the government and for example under Advanced Tax some say under Advanced Tax process if more tax has been paid then what is actually due at the end of the year in that case that Advanced Tax has means that extra tax Surplus tax paid by this company has to be refunded back by the income tax department to the company so if it is relating to the manufacturing business which the company is involved into then that refund of the tax is also the

considered as income from operations cash receipts relating to the Futures forwards options and swap contracts when these are held for dealing or trading purposes if any uh cash is received on account of these These are the derivative products these are Futures forwards options and swaps these are the derivative products and any cash received on account of these derivative products we will have to consider it say say for example now the company is entering into uh to say protect its share price in the market or if the company has uh some investment mean have that kind

of the say say forward agreements or some future agreements or options agreement say for example there is interest rate swaps now companies uh say say borrowing want to borrow at the fixed rate of interest but the bank is ready to give the loan to the company at the fluctuating rate of interest or the variable rate of interest so what the company has to do company has to uh to to borrow from the banker the variable rate of interest and to swap the interest with the other company who trusty to take the loan from the bank

at the variable rate of interest but the bank is ready to give them to the at the fixed rate of interest so if there is any kind of the because of that interest rate swaps if any income is there that income will be derivatives income and that will be considered as but that swap that boring that loan and the swap should have been for the trading purpose not for the investing or financing purpose or for the speculations in that case if it is for the trading purpose then there is no issue it can be considered

as the cash from operations and here are the sources of or maybe the Avenues of the outflow and they are in terms of cash payments to the suppliers for goods and services when it's a manufacturing organization they are buying the raw material they are maybe getting some services so maybe it's a service rendering Organization for example let say it service rendering organization and this company before giving the services to their their final clients they also get some softwares developed from their say suppliers so in that case if they are getting any service or a material

or any purchases they are making that is also the operating outflow then cash payments too and on behalf of the employees when salaries are paid to employees wages are paid to workers any bonus any kind of the other benefits say for example uh if the company's employees are insured and Company's making the payment of their insurance premium to the insurance company maybe on the behalf of their employees or the company's employees compan is getting them insured then that payment is also considered as the operating outflow cash payments of income taxes unless they can be specifically

identified with the financing and investing activities all kind of the income tax payments if they are only on the profit from the operations any profit from the operations and any tax is paid on account of that that has to be considered as the operating cash flow and that has can be taken into account and similarly here as inflow is there on account of derivatives here outflow can be there for the derivatives so any account any any any outflow of the interest on account of the derivatives if it is Flowing out any payment of the interest

if the government company has to make on account of any derivative products if company has to pay uh some cash and cash outflow takes place and those derivatives which are used for the trading purpose then that outflow is also considered as a say cash outflow on account of the operating activities then we talk about the cash flow from investing activities here again we have to look at the same thing investing what are the Investments basically what are the Investments and what are the investing activities as per the International Accounting standard committee and the same thing

as it is interpreted and accepted in the Indian scenario by The Institute of Chartered Accountants of India under the accounting standard three so inflows on account of investing activities that is cash receipts from the disposal of the fixed assets and Tang tangibles if company has some machinery and that Machinery now has become useless and if it is sold or replaced with the new machine then the sale proceeds of that is bringing in some cash to the firm so that is also considered as a cash inflow from the sale of the fixed assets or the tangible

assets cash receipts from disposal of shares warrants or debt instruments of other Enterprises and interest in joint ventures accept the receipts from those instruments considered to be cash equivalents and those for held for dealing or the trading purpose so any investment if this company or a company in question has made in the other company if that is sold in the market that share is sold in the market or share in the joint venture sold in the market then that income that inflow is also considered as inflow from the investing activities provided that inflow is not

on account of those shares which are here for the trading purpose its own company it's only investment made outside if that investment share is sold in the market in that case yes that is the investing inflow cash receipts from the repayment of advances and Loans made to third party except advances and Loans recovered by a financial Enterprise if it is a manufacturing company and if they had given some loan to somebody and now that loan is coming back say for example we have the loans and advances as the current assets if that loan is coming

back that inflow is also considered because that loan was given with the intention of investing the Surplus cash out so what is the inflow coming back is that is considered as the investing inflow then we have the cash cash receipts from future forwards options and S contracts except when the contracts are held for dealing or trading purposes or the seips are classified as financing activities any investment if it's only investment made in any kind of the Futures and forward contracts and if any cash is received from those future or forward contracts that is also considered

as a because that is held only for the investment purpose earlier I told you that is the interested swaps that is that was only for say making the operations smooth and we need the funds for that so we have to use the interest rate swaps so using the interested swaps for the trading purpose is different and using the swaps and this futur and forwards and options for the investment purpose is different so we have to look at the purpose and if any uh cash is flowing in from any kind of the derivatives which is not

for the trading purpose they were not held for the trading purpose they were for the investing purpose investment purpose that this inflow is considered as investing cash inflow similarly that if it is the inflow on the sale of assets so when we purchase the fixed assets we call it as the investing outflow when any plant building machinery land is purchased by the company for making its business smooth then it's called as the investment and investment is mean investment in the assets is fixed assets is considered as the cash outflow for buying those fixed assets is

the outflow occurring on account of the purchase of the fixed assets cash payment to acquire fixed assets and intangibles maybe any copyright patent we have to uh use so that is basically intangible that's only a right that's only a uh patent we are going to use that and we are paying any any price for that and that's going to be asset with the firm mean any patent is with the compan is buying temporarily any copyright company is buying temporarily then till the time it is used by the company it's considered as a asset as good

as a tangible asset so any cash paid out for that purpose is considered as the cash out investing cash outflow cash payments to acquire shares warrants or debt instruments of other Enterprises and interest in joint ventures means when we are selling the shares purchased earlier that's again only for the investment purpose that is inflow and for buying the shares in the other Enterprises of or or of the other Enterprises or in the joint ventures of our companies except they are not held for the trading purpose in that case that is considered for buying any kind

of investment instruments even mutual funds that is considered as the investing cash outflow then cash advances and Loans made to third parties accept the advances and Loans made by the financial Enterprise when we make investment of the surplus funds outside the company we give the loans and advances to the people so as in it is inflow here similarly when the loans are receiv received back it is in flow investing inflow and when the loans are given then they are investing outflow similarly cash payment for the future forwards options and swap contracts except when these contracts

are held for the dealing or the trading purpose if you uh have any if you buy any kind of the contracts swaps Futures forwards options then basically yes it's a cash outflow because we are buying these instruments with the investment purpose not for the trading purpose so these are the say activities considered as investing activities and any kind of inflow or outflow taking place on account of these activities is called as the cash flow from the investing activities similarly we talk about now the next part that is the cash flow from the financing activities now

what are the financing activities they are also clearly categorized so uh so the examples are cash proceeds from issuing shares or the other similar instruments financing generating resources for the or sources of Finance for the firm if we are issuing any shares in the market companies coming out with an IPO or fpo or issuing any shares in the market then that say inflow of the funds coming in capital inflow or the share funds inflow coming on account of the share Capital that is considered as the financing and flow and similarly then the cash is repaid

back for example company's buying back the shares mean you're returning the money and buying back the shares similarly when the company is say returning the loans back means any borrowed money if it is being returned back then it is considered as a financing outflow and then next thing is Cash proceeds from issuing Dentures loans notes bonds and other short or the long uh term borings when we are borrowing the funds it's the inflow and when they are being redeemed or being paid back so that is considered as the cash outflow on account of the financing

activities so these are the two broad sources normally the long-term sources with the firms are what number one is the share Capital second is the loans and dentures and bonds so when the shares are issued cash is received it's inflow when the loans are taken and debenture or bonds are issued again inflow when the shares are being bought back it is the outflow and similarly when the loans are being returned or dentures are being redeemed bonds are being redeemed it is considered as the financing outflow so these are the very clearly defined activities three kind

of the activities that is operating investing and financing activities and we have to clearly categorize it that how much cash is flowing in and going out on account of the operations how much cash is flowing in and going out on account of the Investments and how much cash is flowing in and going out on account of the financing activities and so that we can now it can be possible that even a manufacturing organization though they are incurring a loss in say last 2 3 four years it's a loss making organization but say they had Surplus

land and in one particular year they sold the land worth rupees say 20 crores and because of that inflow of the cash we have got now the say positive cash flow or the balance shown in the cash uh balance sheet cash balance shown in the balance sheet is a is a very Hefty amount will be a very good amount so we may be confused that this cashes or inflow or the cash balances because of the high profitability of the firm whereas it is not the case it is by selling the fixed Assets in the market

so when it happens we should be able to any Outsider who is not involved into day-to-day Affairs of the company he should be able to make out that this cash is flowing in on account of the sale of fixed assets not because of any other reason so that is the important issue so we have to say differentiate that is what is considered as operating inflow what is considered as the investing inflow and what is considered as the financing uh sources of the cash inflow and outflow both and then we'll have to take the uh necessary

decisions here we talk about the something little about the liquidity management so when we talk about the liquidity management so as I told you earlier also that firms to maintain the liquidity they should have sufficient amount of the cash they should have sufficient amount of the cash but you see when we have cash or we keep cash I have also shared this thing with you that keeping a large amount of the cash is also not good because these all assets including cash mean inventory receivables cash cash is also a current asset and these current assets

don't earn any income if they're kept in the form of the cash say cash is kept in the form of the cash I'm not talking about inventory and receivables but when you keeping cash as a cash and large amount of the cash in the cash form in that case what is happening that it's not earning anything good for us it is only a you can call it as asset and without any kind of incomes so what should be done to maintain a liquidity we should have two ways to keep the to maintain the liquidity one

is you keep the pure liquidity that is you keep the cash sufficient amount of the cash so that when any current liability becomes due to be paid we have the sufficient funds for that and if sometimes we know that we don't require the cash Beyond a particular level or the Beyond a particular point then that extra cash should be invested into the short-term Investments today we have the very shortterm investment maybe call deposits 24 hours you can give the money to used by somebody maybe weekly deposits or maybe fortn nightly Investments so these Investments are

called as marketable Securities so Surplus cash should be estimated regularly and whatever the excess cash found with the firm that should be invested so when you keep part of the cash as a cash and part of the cash as a marketable Securities so cash part is considered as the pure liquidity and the marketable Securities part is considered as the near liquidity so as and when you need it you can convert the marketable Securities into cash and you can use it so that way the liquidity should be maintained and and then means finally but when we

go to the market say is called as a backup liquidity also P me near liquidity or the backup liquidity also but that say marketable Securities creation should be having two important considerations one is the return on investment how much investment we are making for how much time we are investing this money and how much return we are expecting second thing is the construction of the portfolio a proper portfolio should be constructed so that the total amount of the cash is not invested in the risky Securities or where there is a doubt whether it will be

available on demand or not so proper portfolio construction is important and then you have me you have to have the combination of both Cash Plus marketable Securities that will be the better option so now we have learned about that how to manage the this cash flow statement or this process of managing the cash and here there are some other important points to be taken into account that cash management techniques are also important if you want to improve the cash process or if you want to have say uh productive uh cash with us and we want

to keep the cash properly managed so here are some important points they should be born in mind that number one is that if you want to keep a Optimum amount of the cash not more not less so that the payments due can also be made on time and if there is any surplus cash that can be diverted to the marketable Securities in that case what is to be done that we have to go for the proper synchronization of the cash flows synchronization means we can use the budgeting process cash budgeting process and the budget Horizons

can be 1 week or 15 days so if you are able to have a weekly budgeting system cash budgeting system in the beginning of the week or maybe at the end of the previous week you can make the budget for the next week that how much cash we miss total cash that how much cash is going to flow in to the form next week and how much cash is expected to flow out so that you know well in advance that whether end result is going to be Surplus or deficit of cash so it's going to

be this going to be there going to be Surplus you can look forward that if this much cash is going to be Surplus how I have to make the proper investment of the cash and if there is a short for of the cash then from where I have to arrange it so that when this time comes that when you have the Surplus cash you know where it has to go and there is a shortage then you already know that where it has to come from so that the payments are made on due date there is

no technical insolvency so for that reason we'll have to go for the proper synchronization and synchronization can be facilitated with the help of the cash budgeting and the cash budgeting is possible if you want to bring down the time Horizon from say 1 month months to 15 days or one week then you have to have a better improved it systems put in place you have to put in place the better improved it systems which keep on automatically preparing the cash budgets and we can uh easily find out how much is Cash is Flowing out how

much cash is flowing in so that there is no problem and you can run the show even by keeping a less than Optimum amount of the cash also so that the cost can be reduced and the say return uh of that Surplus cash invest in that cash outside can be improved then we can speed up the check clearing process now these days business receive the cash uh with the help of checks or sometimes with the help of say online also so now the FMS should try that if they are say making the payments they should

make the payments through check but if they have to receive the cash then the cash should be received online or if it is check system in both the cases that cash is coming in from the with the help of check and going out with the help of check in that case uh the collection should be a clearing system should be very very prompt means what they should do that when the cash check comes in is received by the farm immediately that should be sent to the bank so that it's collected as early as possible if

you delay the cash collections if you delay the cash clearing and the cash collections again it has a cost and ultimately artificially it reduces the cash balance whereas the fir has more cash balance but when the collection system clearing system is poor then the FM is not able to identify how much cash they already have and they are not able to make the proper use of that that cash so that has to be done and then we have to go for the uh say uh another thing we can technically do that is we can use

floats we can use floats so I think you must not have heard what is a float system so float is basically of three kinds one is the dispersement float other is the collection float and third one is the net float dispersement float means when any payment the form has to make they should try to mean they should make the payment in such a way that form has issued the check to the supplier or to whom the payment has to be made but they clearing processed by the me uh when the the check is put uh

in the bank by the by by the receiver of that check that check is taking a longer time for clearing for example it can be possible that say there is one company having uh there are two companies buyer and supplier so buyer is buying the ra material from the supplier and both the companies are in Delhi and they have means the buyer has got an arrangement made with the help of with the agreement of supplier the do you will keep me supplying the product uh and you will give me the credit period for 1 month

after 1 month I'll make you the payment through check and the check will be issued by our ghati office not by the Delhi office because if check is issued by the Delhi office and the receiver is also in Delhi so what will happen immediately the check will reach him he'll put it in the bank and local clearing within I think uh 3 days the money will be transferred but if that company who is the buyer if he's having economic might Financial might they can say that we have open office in ghati and from goti all

the payments are made so you will receive the check and you will get the uh payment so you see on the due date then say company may send the check from ghati and maybe on the uh end of 30th Day evening the check reaches or maybe the next day check reaches the supplier's office then what will happen check supplier will deposit that check in the bank check check will go to ghati and then it will come back so clearing will take about 2 weeks time so have mean you can do more business by delaying the

disbursement you're dispersing the payment also but actually payment is not getting debited from the paying company's account and receiver feels that we have received the payment but payment is actually not received by them that could be called as a dispersement float and second is a collection float that when any company has to receive the payment it should be their approach that they receive it on the due date maybe it's a check they receive it from the nearest office nearest Branch or nearest office so that immediately it is received put in the bank for collection clearing

and within 2 3 days the payment is collected by the so for dispersement the approach should be that you take you enjoy more time you make the payment but that check clearing takes more time so you could make that kind of arrangements for receiving the uh receipts you can have the arrangement that it receiv from the near Office of the buyer and immediately he sends the check and form is receiving the check check goes to the bank and clearing is done and net float means the difference between the dispersement float and the collection float so

for example dispersement float is that when any company X company makes the payment to Y company so X company gives a check and this is the dispersement float for X company so dispersement float for the X company is 4 days that after 4 days the payment is transferred to the account of buy company right but when this company maybe and and X company is dealing with the Zed also so X compan is making the payment to zed so or say uh X company is dealing with the Zed also and Zed is the buyer from the

X and Zed is making the payment to the X so when X receives the money from Zed it is from the nearest office so this is called as collection float so this collection float is for example it is of two days the then yet their payment X payments are made to buy in 4 days means after 4 days the X account is debited by the clearing process uh initiated by the buy and here in this case X is receiving the payment and then the Zed has to make the payment so that is called as a

collection so X is so prompt that immediately they receive the check they send it to bank and within 2 days the clearing is done so it means net float will be 4 minus 2 that is 2 so Farm should try to maximize the net floats and after that other than that they can have some collection process collection of the funds process can also be improved for that they can use the lockbox plan or online transfers can be online transfers can be say accepted or they can be allowed so when we talk about the lockbox plan

lock box means there is one uh box in the branch and almost nearby peers are informed that you go and put their check in that box and that branch is authorized by the company that you take open the box take out the checks and credit those checks in our account so that will facilitate speed of the collection process so number one that synchronization should be better then the clearing should be better collection should be better net float should be improved and say the collection process of uh the money the the funds which are due to

be received should be improved so this is some theoretical foundation of the cash flow statement which I'm say ending here not taking you further fur so your see important concern here is learning how to prepare the cash flow statement by say dividing the cash inflow and outflow into operating investing and financing activities and that we will be learning and we will be analyzing that cash flow statement and that is our job and that is our purpose here so uh learning how to prepare the cash flow statement I'll be talking to you in the next part

of discussion thank you very much [Applause] [Music] w [Music]