Tata McGraw Hill Professional: Finance Made Easy Series How to Read A CASH FLOW STATEMENT Tata McGraw Hill Professional: Finance Made Easy Series Financial success is the raison d’être of any business, and fi nancial health of any organization is refl ected in its fi nancial statements. But, it has been observed that managerial professionals often have little understanding of fi nance and little time to read treatises on it. Further, fi nancial statements are regarded as too complex to understand and left to be ‘deciphered’ by fi nance experts. Hence, cultivating a culture of awareness and transparency of fi nance is a prime imperative. Finance Made Easy Series has been designed to impart management executives with adequate knowledge to understand and appreciate fi nancial statements and their implications for the fi scal solvency of their fi rms. Th is series seeks to demystify apparently complex fi nancial statements, and help create a fi nance-savvy executive class, the key to fi scally sound and successful businesses. A lucid, creative and concise exposition of fi nancial statements—their components, jargon and computational methods— with short stories and numerical examples makes for an engaging reading for busy professionals. Titles in the series include: • How to Read a Balance Sheet • How to Read an Income Statement • How to Read a Cash Flow Statement and many more… Tata McGraw Hill Professional: Finance Made Easy Series How to Read A CASH FLOW STATEMENT N. Ramachandran Principal Consultant Management Advisory Services Kochi Ram Kumar Kakani Associate Professor, XLRI Jamshedpur Tata McGraw Hill Education Private Limited NEW DELHI McGraw-Hill Offi ces New Delhi New York St Louis San Francisco Auckland Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal San Juan Santiago Singapore Sydney Tokyo Toronto Tata McGraw Hill Published by Tata McGraw Hill Education Private Limited, 7 West Patel Nagar, New Delhi 110 008. Copyright © 2010, by Tata McGraw Hill Education Private Limited No part of this publication may be reproduced or distributed in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise or stored in a database or retrieval system without the prior written permission of the publishers. The program listings (if any) may be entered, stored and executed in a computer system, but they may not be reproduced for publication. This edition can be exported from India only by the publishers, Tata McGraw Hill Education Private Limited. ISBN (13): 978-0-07-068071-5 ISBN (10): 0-07-068071-X Managing Director: Ajay Shukla Head—Professional and Healthcare: Roystan La’Porte Executive Publisher—Professional: R Chandra Sekhar Assistant Sponsoring Editor—BGR: Dipankar Das Production Executive: Rita Sarkar Manager—Sales & Marketing: S Girish Assistant Product Manager—BGR: Priyanka Goel General Manager—Production: Rajender P Ghansela Asst. General Manager—Production: B L Dogra Information contained in this work has been obtained by Tata McGraw Hill, from sources believed to be reliable. However, neither Tata McGraw Hill nor its authors guarantee the accuracy or completeness of any information published herein, and neither Tata McGraw Hill nor its authors shall be responsible for any errors, omissions, or damages arising out of use of this information. This work is published with the understanding that Tata McGraw Hill and its authors are supplying information but are not attempting to render engineering or other professional services. If such services are required, the assistance of an appropriate professional should be sought. Typeset at Tact Computer Graphics, A-118, St. No. 6, West Azad Nagar, Krishna Nagar, Delhi 110 051, and printed at Rashtriya printers, M-135, Panchsheel Garden, Naveen Shahdara, Delhi-110 032 Cover Design: Kapil Gupta RCDCRRCZRXXAA The McGraw-Hill Companies To Our Dear Student Preface F inancial success is arguably the primary purpose around which, all business management activities revolve. It is imperative to promote a culture of fi nancial discipline in an organization. In order to build an economically viable company, the employees, in all departments, need to understand the fi nancial ramifi cations of their action on the overall fi scal health of the organization. For this to happen, it is very important that not only fi nance managers, but managers in all other fi elds too have an adequate knowledge of the subject. Th e pervasiveness of such knowledge could ultimately help differentiate a successful organization from a bankrupt one. Th e series of books, Finance Made Easy Series, has been written for management executives, to impart the knowledge required in order to understand the basic financial statements. The Finance Made Easy Series is an attempt to break the myth that fi nancial statements such as the Income Statement, Cash Flow Statement and Balance Sheet are too complex to comprehend. Th is particular book deals with Cash Flow Statement. In the race for profi ts, companies quite often ignore the need of having cash to maintain liquidity of the business. It is by looking at the cash fl ow statement that we gauge the actual liquidity position of a company, and the fi nancial planning required for maintaining the same. Th is statement informs the company of regular movements in its funds, allowing it to manage daily functions more effi ciently. viii Preface Th erefore, it becomes imperative for the key decision-makers of a business to have at least rudimentary knowledge about the cash fl ow statement, and its impact on the business. It is with this confi dence that we claim that this book will be an ideal guide in helping you to manage the company funds better. We hope readers will appreciate the simple language in which this book is written to reduce all the unnecessary accounting jargons and present the concepts in an easily comprehensible format. NEELAKANTAN RAMACHANDRAN RAM KUMAR KAKANI Acknowledgments O ur peers at ICAI, ICWA, IIMs, XLRI, and other premier academic organizations have continuously inspired our thinking. For this book, our research associates immensely contributed to the manuscript development. We are indebted to: • Kamlesh Th akkar, CA • Mary Johnny, BA • Nutan Shashi Tigga, MA • Prasun Mallik, MBA • Rakesh Sinha, MBA • Rohit N Barchha, CAI • Vasudha Singhania, CA We would like to thank Dipankar Das, Rita Sarkar, Sindhu Ullas and other team members of the Tata McGraw Hill Professional. In particular, we thank R. Chandra Sekhar whose skillful persuasion and editorial work helped clarify and steady our work enormously. Finally, we are grateful to our family members including – Ananya, Chinku, Dhruva Govind, Kanan, Karuna, Kriti, Kunju, Leena, Rathis, and Vipra. Th ank you all! Comments from readers are most welcome (Email: ramkumarkakani@ gmail.com). NEELAKANTAN RAMACHANDRAN RAM KUMAR KAKANI Contents Preface vii Acknowledgments ix Introduction 1 1. Funds 3 Funds 3 Operating Cycle 5 2. Th e Working Capital 7 Working Capital 7 Flow of Funds 8 Need for Working Capital 9 Reconciling Increase in Working Capital 16 3. Capital Invested In Business 17 Need to Invest in Cash 17 Need to Invest in Receivables 18 Need to Invest in Inventory 18 Need to Invest in Fixed (Non-current) Assets 19 Determining the Working Capital Requirement 19 xii Contents Future Capital Requirements 22 Possible Sources of Working Capital 25 4. Factors Aff ecting Fund Requirements 29 5. Th e Fund Flow Statement 33 Th e Format 34 Funds Flow from Operations 34 Statement of Changes in the Working Capital 39 Changes in the Financial Position 43 Fund Flow Statement Illustrated 44 6. Th e Cash Flow Statement 48 Th e Need for a Cash Flow Statement 51 Cash and Cash Equivalents 52 7. Preparing A Cash Flow Statement 55 Format 55 Preparing Cash Flow Statement: An Introduction 57 8. Solved Illustrations 66 Summary 76 9. Exercise 78 Index 81