Accounting Standard 3 specifies the provisions related to the Cash Flow Statements. It is one of the important principles of Accounting. The information about daily inflow and outflow of cash and historic changes in the same is very important for every business. To take any decisions, cash flow statements help to evaluate the capacity of an enterprise to generate cash and cash equivalents, the timing and their certainty of generating cash inflow.
What is the cash flow statement?
In simple terms, it a statement indicating inflows and outflows of cash and cash equivalents. It is a statement that provides detailed analysis by which enterprises can determine the capacity of an organisation to generate cash and cash equivalents and planning on utilising such available cash into the business. The enterprises regularly evaluate cash inflows and outflows for effective decision making on utilising funds.
What are the benefits of preparation of cash flow statement?
- It provides information regarding the liquidity and solvency of the company.
- It provides historic data regarding cash inflows and outflows, which helps the organisation to take effective decisions.
- It helps to evaluate changes in the net assets, their ability to affect the financial structure of the companies.
- It helps in making a wise decision on the applicability of funds, determined on the basis of the timing of cash flows.
- Historical data is useful in checking the accuracy of the past assessments of future outflows.
- With changing prices, the relationship between profitability and net cash flow can be determined.
What do cash and cash equivalents include?
Cash comprises cash on hand and demand deposits at Bank. Whereas, cash equivalents are short term investments that can easily be converted into cash.
Examples of cash include:
- Cash in hand
- Cash at Bank
- Bank drafts
- Money orders
- Petty Cash
Examples of cash equivalents include:
- Commercial papers
- Treasury Bills
- Marketable Securities
- Short term government bonds
- Money Market Funds
There are two important criteria to determine the cash equivalent:
- It should be easily convertible into cash and
- The risk involved in the realisation of value should be less
Cash Flow statement is classified under 3 activities
- Operating Activities - these are related to principle- revenue-generating activities
- Investing Activities - Investment activities include acquisitions or disposal of long-term assets. Such investments are not included in cash equivalents.
- Financing Activities - it includes capital contribution and borrowings of the company.
Applicability of Cash Flow Statement under Companies Act, 2013
The applicability of the Cash Flow statement can be determined under the definition of “Financial Statements” (Section 2 (40) of the Companies Act, 2013) and is governed by Companies (Accounting Standard) Rules, 2006.
What does the Financial Statements of a company include?
The definition of financial statements states that the Financial Statements in relation to Company include:
- a balance sheet as at the end of the financial year;
- a profit and loss account, or in the case of a company carrying on any activity, not for profit, an income and expenditure account for the financial year;
- cash flow statement for the financial year;
- a statement of changes in equity, if applicable; and
- any explanatory notes annexed to or forming part of, any document referred to in relation to (1)-(4) above.
Which companies are exempt from the applicability of Cash Flow Statement?
The financial statements of following companies may not include the cash flow statement
- One Person Company (OPC) - means a company which has only one single person as to its member.
- Small Companies - Small Company means a company, other than a public company, whose paid-up capital does not exceed Rs. 50 lacs and Turnover (as per preceding financial year) does not exceed Rs. 2 crores.
However, the definition of a small company does not include:
a. Holding compy or subsidiary company
b. A company registered under Section 8
c. A company or body corporate governed by any special Act.
- Dormant Companies - these are inactive companies formed for any future projects or only to hold assets and has no significant transactions.
- Start-up Private Companies - A start-up company means a private company incorporated under the Companies Act, 2013 or The Companies Act, 1956 and recognised as star-up in accordance with the notification issued by Industrial Policy and Promotion, Ministry of Commerce and Industry (inserted vide Notification dated 13th June 2017)
Therefore, apart from the above-mentioned companies, all public limited companies, listed companies and private limited companies are required to include cash flow statement in their financial statements.
What are the methods of preparing the Cash Flow Statement?
Accounting Standard 3 prescribes 2 methods for the preparation of Cash Flow Statement.
- Indirect Method and
- Direct Method
Provisions under Companies Act, 2013 for preparation on Financial Statements
Section 129 read with Schedule III of Companies Act, 2013 provides that the Cash Flow statement wherever applicable shall be prepared in accordance with the relevant accounting standard as recommended by the Institute of Chartered Accountants of India, in consultation with and after examination of the recommendations made by the National Financial Reporting Authority. (as provided under Section 133 of the Act).
FAQs on Cash Flow Statement
Is cash flow statement applicable to a private company?
Yes, Cash Flow statement is applicable to all private limited companies except:
- One Person Company
- Small Company
- Dormant Company and
- A Private Limited company recognised as a start-up in accordance with the notification issued by Industrial Policy and Promotion, Ministry of Commerce and Industry
Is the preparation of cash flow statement mandatory for the subsidiary company or holding company?
Yes, the Subsidiary company or holding company is not considered as a small company, hence preparation of Cash Flow Statement is mandatory for both.
Do small companies required to prepare a Cash Flow Statement?
As per the definition of financial statements (Section 2 (40) of the Act), the cash flow statement is not applicable to small companies. But,
Condition 1: The definition of a small company makes it mandatory to fulfil both the conditions i.e. paid-up capital and turnover, as there is “and” between both the conditions. If any one of the conditions is triggered then the company loses its status as a small company.
Condition 2: In the definition, for turnover criteria, it is specifically mentioned that “Turnover as per Profit and Loss account for the immediately preceding financial year.” Therefore to check the applicability for the current financial year, it is necessary to check the profit and loss account of the immediately preceding financial year.
For example: To check whether a company is a small company for the FY 2019-20, the turnover as per profit and loss account for FY 2018-19 should be checked. If turnover has crossed Rs. 2 crores as on 31.03.2019, then Financial Statements for FY 2019-20 should include cash flow statement.
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