AHSEC - 12: Cash Flow Statement Important Notes for March 2025 Exam [AHSEC Class 12 Accountancy Notes]

Class 12 Accountancy Notes

Unit – 10: Cash Flow Statement

Important Notes for March 2025 Exam [AHSEC Class 12 Accountancy Notes]

Q.1. What is Cash Flow Statement? What are its objectives? Mention its uses and Limitations.  2012, 15, 16, 17, 19, 22, 2024

Ans: Cash Flow Statement:  Cash­ flow is made up of two words i.e. Cash and Flow, whereas Cash means cash balance in hand including cash at bank, and Flow means changes (which may be increase or decrease) in the cash movements of the business. So, Cash Flow Statement is a statement which shows the movement of cash and cash equivalents over a particular period of time and also analyses the reasons for changes in balance of cash in hand and at bank between two accounting period. It shows the inflows and outflows of cash and cash equivalents.

Objectives/Importance/Uses/Significance of Cash Flow Statement                          2013, 2016, 2017, 2020

The Cash Flow Statement is prepared because of number of merits, which are offered by it. Such merits are also termed as its objectives. The important objectives are as follows:

a)       To Help the Management in Making Future Financial Policies: Cash Flow statement is very helpful tool to the management. The management can base its future financial policies and is in a position to know about surplus or deficit of cash with the help of cash flow statement.

b)      Helpful in determining the ability to pay dividends: Cash flow statement indicates the various sources and uses of cash under different heads which helps the shareholders to know whether the business can make the payment of dividends on their investment or not.

c)       Efficient Cash Management: It helps in efficient management of cash resources. It will help the management to make the reliable cash flow projections for the immediate future and will tell surplus or deficit of cash so that management can make plan for the investment of surplus cash or to arrange the sources to meet the deficiency.

d)      To test management efficiency: Comparison of actual and budgeted cash flow statement will disclose the failure or success of management in managing cash resources. In case of failure remedial steps can be taken to improve the position.

e)      Helpful in devising the cash requirement:  Cash flow statement is helpful in devising the cash requirement of the business for repayment of liabilities and replacement of fixed assets.

f)        Helpful in predicting sickness of the business:  Cash flow is helpful in predicting sickness of the business. A sound cash position is a true indicator of sound financial position.

LIMITATIONS OF CASH STATEMENT

Though the Cash Flow Statement is a very useful tool of financial analysis, it has its limitations which must be kept in mind at the time of its use. These limitations are:

a)       Non-cash Transactions are ignored: Cash flow statement is prepared on cash basis. It shows only inflows and outflows of cash. It does not show non-cash transactions like the purchase of buildings by the issue of shares or debentures to the vendors or issue of bonus shares or depreciation which largely affect the results and position of the business.

b)      Historical in Nature:  It rearranges the existing information available in the income statement and the balance sheet. It is historical in nature. It will become more useful if it is accompanied by the projected Cash Flow Statement.

c)       Ignorance:  It is prepared on cash basis of accounting. It ignores basic accounting concept, i.e., accrual concept.

d)      What is Cash: It is difficult to precisely define the term ‘cash’. There are controversies over a number of items like cheques, stamps, postal orders, etc. to be included in cash.

e)      Does not reveal true liquidity position: A Cash flow statement reveals only the inflow and outflow of cash but the exclusion of near cash items from cash flow statement limits the true reporting of the firm’s liquidity position.

f)        Working Capital ignored: Working Capital is wider concept of funds than cash. A funds flow statement presents a more complete picture than cash flow statement. Also chances of window dressing are more in case of cash position in comparison to the working capital position.

Q.2. How cash flow statement is prepared? Or What are various classification of Cash flows? Give four examples of each.        2013, 2017, 2022, 2024

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ALSO READ (AHSEC ASSAM BOARD CLASS 12):

1. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE NOTES

2. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION (THEORY)

3. AHSEC CLASS 12 ACCOUNTANCY IMPORTANT QUESTION BANK (PRACTICAL)

4. AHSEC CLASS 12 ACCOUNTANCY PAST EXAM PAPERS (FROM 2012 TILL DATE)

5. AHSEC CLASS 12 ACCOUNTANCY SOLVED QUESTION PAPERS (FROM 2012 TILL DATE)

6. AHSEC CLASS 12 ACCOUNTANCY CHAPTERWISE MCQS

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Ans: Cash flow statement is a statement which shows the movement of cash and cash equivalents over a particular period of time. It comprised of three sections: Operating activities, investing activities and financing activities. There are two methods of preparing cash flow statement: the direct method preferred by FASB and indirect method preferred by most businesses because of its simplicity. The difference between the two methods lies in the operating section only. Investing and financing activities calculation are same under both the methods.

A) Section one: Cash flow from operating activities: Operating activities are the principal revenue generating activities of the business. These are cash flows from regular course of operations such as manufacturing, trading etc. All activities that are not investing or financing activities are included under operating activities.

Examples of Operating Activities: 2013, 2023 (Sources and applications of cash flow)

Ø  Cash receipts from the sale of goods and rendering of services. (Source)

Ø  Cash payments to suppliers of goods and services. (application)

Ø  Cash receipts from royalties, fees, commission and other revenue. (Source)

Ø  Cash payments to and on behalf of employees for wages, etc. (application)

Ø  Cash payments and refunds of income taxes. (application)

Under indirect method cash flow from operating activities is calculated with the help of net profit before tax and extraordinary items. Non-cash and non-operating expenses and losses are added and non-cash and non-operating incomes are deducted from net profit before tax and extraordinary items to find net cash flow from operating activities before working capital change. After this changes in working capital is adjusted and payment of taxes during the year is deducted to find cash flow from operating activities.

B) Section two: Cash from investing activities: The investing activities of a business include all cash flow arises due to acquisition and disposal of long term assets (whether tangible and intangible) and investments. Acquisition or disposal of companies also comes under investing activities. These are separately disclosed in cash flow statement.

Examples of Investing Activities: 2013, 2019, 2023 (Sources and applications of cash flow)

Ø  Cash payments to acquire long term fixed assets (tangible and intangible) and investments. (application)

Ø  Cash receipts from the disposal of long term fixed assets (including intangibles) and investments. (Source)

Ø  Cash payments for purchase or of shares, warrants, or debt instruments of other enterprises and interest in joint ventures. (application)

Ø  Cash receipts from sale of shares, warrants, debt instruments of other enterprises and interest in joint ventures. (source)

Ø  Cash receipts from repayments of advances and loans made to third parties. (source)

All the sources of cash from investing activities are added and all the applications of cash in investing activities are deducted to find net cash flow from investing activities.

C) Section three: Cash flows from financing activities: Financing activities are the activities which results in changes in the size and composition of the owner’s capital and borrowings of the enterprises from other sources. The financing activities of a firm include issuing or redemption of share capital, issue and redemption of debentures, raising and repayment of long term loans etc. Dividends and Interest paid are also come under financing activities. 2018

Examples of Financing Activities: (Sources and applications of cash flow) 2022

Ø  Cash proceeds from the issue of shares or other similar instruments. (source)

Ø  Cash proceeds from the issue of debentures, loans, bonds and other short term borrowings. (source)

Ø  Buy-back of equity shares. (application)

Ø  Cash repayments of the amounts borrowed including redemption of debentures. (application)

Ø  Payments of dividends and interest on borrowings. (application)

All the sources of cash from financing activities are added and all the applications of cash in financing activities are deducted to find net cash flow from financing activities.

Last section – Bottom line: All the cash flows from three sections are added to find net cash flow during the year. Thereafter opening balance of cash and cash equivalent s are added with this amount and the resulting amount will be the closing balance of cash and cash equivalents. Here cash and cash equivalents means:

Cash: Cash comprises cash on hand and demand deposits with banks.

Cash Equivalents: Cash Equivalents are short-term, highly liquid investments that are readily convertible cash. Examples of cash equivalents are: (a) treasury bills, (b) commercial paper, (c) money market funds and (d) Investments in preference shares and redeemable within three months.         (2018, 2023, 2024)

ALSO READ: ACCOUNTANCY CHAPTERWISE COMPLETE NOTES

1. BASICS OF PARTNERSHIP (INCLUDING GOODWILL)
2. RECONSTITUTION OF PARTNERSHIP (ADMISSION, RETIREMENT AND DEATH)
3. DISSOLUTION OF PARTNERSHIP FIRM
4. ACCOUNTING FOR SHARE CAPITAL
5. ISSUE AND REDEMPTION OF DEBENTURES
6. FINANCIAL STATEMENTS OF A COMPANTY
7. FINANCIAL STATEMENTS ANALYSIS
8. RATIO ANALYSIS
9. CASH FLOW STATEMENTS

Format of Cash Flow Statement under Direct Method (2022)

Format of Cash Flow Statement under Indirect Method