JAIIB AFM Module-B Unit 5 : Cash Flow and Funds Flow

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Aug 30

JAIIB Paper 3 AFM Module B Unit 5 : Cash Flow and Funds Flow (New Syllabus)

IIBF has released the New Syllabus Exam Pattern for JAIIB Exam 2023. Following the format of the current exam, JAIIB 2023 will have now four papers. The JAIIB Paper 3 (Accounting and Financial Management for Bankers) includes an important topic called "Cash Flow and Funds Flow". Every candidate who are appearing for the JAIIB Certification Examination 2023 must understand each unit included in the syllabus. In this article, we are going to cover all the necessary details of JAIIB Paper 3 (AFM) Module B (FINANCIAL STATEMENTS AND CORE BANKING SYSTEMS ) Unit 5 : Cash Flow and Funds Flow Aspirants must go through this article to better understand the topic, Cash Flow and Funds Flow, and practice using our Online Mock Test Series to strengthen their knowledge of Cash Flow and Funds Flow. Unit 5 : Cash Flow and Funds Flow

Introduction

A cash flow statement, prepared for a period, tells us the position of cash at the beginning and end of that period.
Cash also includes Cash equivalents.
Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.
Information about the cash flow of an enterprise is useful in providing users of financial statements a basis to assess the ability of the enterprise to generate cash and cash equivalents.

Components Of Cash Flow

Let us take the example of a simple trading enterprise which starts its business on 1/04/2022 with its assets and liabilities as under:

On 2/04/2022, the firm buys wheat for Rs. 90,000 for cash and sells it for Rs. 95,000 on cash basis. Its balance sheet changes as under:

It is easy to see that there is a cash inflow of ` 5,000 during the day, due the trading activity, which we call "Operating activity" in Accounting parlance. On 3/04/2022, the firm buys wheat for ` 80,000 for cash and sells it for ` 85,000 on cash basis. It also purchases a weighing machine for ` 15,000 to facilitate its operations. Its balance sheet changes as under:

We can see that there is a cash outflow of Rs. 10,000 during the day, despite trading activity earning a profit of Rs. 5,000 and cash inflow of Rs. 5,000. This is because there was a cash outflow of Rs. 15,000 for purchasing fixed assets. So, the net result was an outflow of Rs. 10,000. This falls among the items which we group under "Investing activity" in Accounting parlance.

On 4/04/2022, the firm buys wheat for ` 75,000 for cash and sells it for ` 80,000 on cash basis. On the same day the proprietor withdraws capital of ` 10,000. Its balance sheet changes as under:

We can see that there is a cash outflow of Rs. 5,000 during the day, despite trading activity earning a profit of Rs. 5,000 and cash inflow of Rs. 5,000.
This is because there was a cash outflow of Rs. 10,000 by way of reduction in capital. So, the net result was an outflow of Rs. 5,000
This falls among the items which we group under "Financing activity" in Accounting parlance.
Such an activity will also affect the net cash flow of the firm

The activities of a business entity are grouped under 3 categories

Operating activities: These are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. Operating activities consist of inflows and outflows of cash resulting from transactions that affect a firm's net profit or loss.
Investing activities: These include acquisition and disposal of long-term assets and other investments not included in cash equivalents. (Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.)
Financing activities: These include activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

Cash Flow from Investing Activities

If an enterprise keeps on having positive cash flows from its operating activities for a very long time, its cash balance will become very high. We have to remember that while cash is a very desirable asset for liquidity, it is also the most unproductive asset and no enterprise would like to have huge cash balances.
Investment of cash in fixed assets or financial assets is a way to deploy this cash. Cash outflows due to investing activities represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. Cash inflows from investing activities means that there is a net decrease in such assets.

Examples of cash flows arising from investing activities are:

Cash payments to acquire property, plant and equipment, intangibles and other long-term assets. These payments include those relating to capitalised development costs and self-constructed property, plant and equipment;
Cash receipts from sales of property, plant and equipment, intangibles and other long-term assets;
Cash payments to acquire equity or debt instruments of other entities and interests in joint ventures (other than payments for those instruments considered to be cash equivalents or those held for dealing or trading purposes);
Cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures (other than receipts for those instruments considered to be cash equivalents and those held for dealing or trading purposes);
Cash advances and loans made to other parties (other than advances and loans made by a financial institution);
Cash receipts from the repayment of advances and loans made to other parties (other than advances and loans of a financial institution);
Cash payments for futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and
Cash receipts from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing

Cash Flow from Financing Activities

Financing activities can be useful in utilising the cash generated through operating of investing activities. These can also be utilises for increasing cash inflows in times of need. Examples of cash flows arising from financing activities are:

Cash proceeds from issuing shares or other equity instruments;
Cash payments to owners to acquire or redeem the entity's shares;
Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short-term or long-term borrowings;
Cash repayments of amounts borrowed; and
Cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease.

Legal Requirement Of Preparation Of Cash Flow Statement

Those business entities which are required to follow the Accounting Standards, have to prepare the cash flow statement also as it forms part of the set of financial statements. AS-3 and Ind AS-7 provide detailed guidelines for preparing this statement. Cash flows are shown separately for each of the three categories of activities. As per the Ind AS- 7, which sets out requirements for the presentation and disclosure of cash flow information, an entity shall report cash flows from operating activities using either:

The direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or
The indirect method, whereby profit or loss is adjusted for the effects of transactions of a non- cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.

Other Important Points Mentioned in Ind AS-7

Some of the other important points mentioned in Ind AS-7 are as under:

Cash flows exclude movements between items that constitute cash or cash equivalents because these components are part of the cash management of an entity rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash in cash equivalents.
A single transaction may include cash flows that are classified differently. For example, when the cash repayment of a loan includes both interest and capital, the interest element may be classified as an operating activity and the loan element is classified as a financing activity.
The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the entity have generated sufficient cash flows to repay loans, maintain the operating capability of the entity, pay dividends and make new investments without recourse to external sources of financing. Information about the specific components of historical operating cash flows is useful, in conjunction with other information, in forecasting future operating cash flows.
The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. Only expenditures that result in a recognised asset in the statement of financial position are eligible for classification as investing activities
The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of capital to the entity.
Cash flows arising from transactions in a foreign currency shall be recorded in an entity's functional currency by applying to the foreign currency amount the exchange rate between the functional currency and the foreign currency at the date of the cash flow. The cash flows of a foreign subsidiary shall be translated at the exchange rates between the functional currency and the foreign currency at the dates of the cash flows. Cash flows denominated in a foreign currency are reported in a manner consistent with Ind AS 21.
Cash flows from interest and dividends received and paid shall each be disclosed separately. These cash flows shall be classified in a consistent manner from period to period as either operating, investing or financing activities. The total amount of interest paid during a period is disclosed in the statement of cash flows whether it has been recognised as an expense in profit or loss or capitalised in accordance with Ind AS 23, Borrowing Costs.
Cash flows arising from taxes on income shall be separately disclosed and shall be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities.
The aggregate cash flows arising from obtaining or losing control of subsidiaries or other businesses shall be presented separately and classified as investing activities.
Investing and financing transactions that do not require the use of cash or cash equivalents shall be excluded from a statement of cash flows. Such transactions shall be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities.
An entity shall disclose the components of cash and cash equivalents and shall present a reconciliation of the amounts in its statement of cash flows with the equivalent items reported in the balance sheet.

Format For Preparation Of Cash Flow Statement

For preparing this statement, items available in the Balance Sheet and the Profit and Loss Account can be used.
There is no prescribed format for preparation of cash flow statement. It may be different for different entities depending upon the peculiar nature of the activities.

An indicative format of the Statement of cash flows is as under:

1.Cash flows from Operating Activities

(a) Operating income (EBIT)

(b) Add: Depreciation

(d) Add decrease in accounts receivables

(e) Subtract Decrease in accounts payable

(f) Add/subtract decrease/increase in other items of current assets

(g) Add/subtract increase/decrease in other items of current liabilities

Net cash flow from operating activities (A)

Cash flows from Investing Activities

(h) Sale of Long term assets

(i) Subtract Purchase of Long term assets

Net cash flow from operating activities (B)

Cash flows from Financing Activities

(j) Payment of dividend (-)

(k) Increase in equity (+)

(l) Decrease in borrowings (-)

Benefits Of Cash Flow Information

Useful in understanding clearly the sources of an enterprise's cash inflows and how this cash is being uitilised.
A statement of cash flows, when used in conjunction with the rest of the financial statements, provides information that enables users to evaluate the changes in net assets of an entity.
its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities.
Useful in assessing the ability of the entity to generate cash and cash equivalents and enables users to develop models to assess its future prospects.
Suppliers can use it to assess the liquidity position of an enterprise which is important to fund its operating expenses and pay its debts.
Bankers and other creditors can use it to decide the repayment schedules of their loans and advances and also stipulate covenants putting restrictions on certain expenses and investments.

Funds Flow Statements

Each item in the balance sheet represents either source of funds or use of funds.
Source of funds: All items on the liabilities side
Use of funds: all items on the assets side (except cash)
Cash in the balance sheet represents the unutilized portion of funds, available to the enterprise.
If cash is also perceived as a use of funds, then all the uses of funds are equal to all the sources of funds.
This perception of available cash, as a use of funds, is what causes the

Difference between Cash Flow Statement and Funds Flow Statement

Preparation Of Funds Flow Statements

For the purpose of preparing the funds flow statement, the information contained in the two subsequent balance sheets is organized into two principal groups;

Sources of funds and
Applications of the funds.

As mentioned in the previous paragraph, sources of funds are indicated by decrease in assets and increase in liabilities (including shareholder's equity) over the previous year while applications of funds are associated with the increase in assets and decrease in liabilities (including shareholder's equity) over the previous year. A funds flow statement can be prepared in various ways depending upon the end use and purpose. Bankers, normally, further classify both sources and uses of funds into Long term and Short term. This enables them to know if long term funds have been diverted for short term uses.

So, an indicative format of funds flow statement, for the bankers, may be as under:

While preparing the funds flow statement, we have to take special care of the following two aspects:

Changes in fixed assets: While comparing the figures of two successive balance sheets, we have to take into account the depreciation charge during the year. We should also know if any assets have been sold during the year. For example: Assume that the figures of fixed assets shown in the balance sheets of 31/3/21 and 31/3/22 are same at ` 5,00,000. This may give the impression that there has been no long term source and use of funds on this account, during the year. But this is not correct. If the depreciation charged during the year is ` 60,000, it means that additional fixed assets of the same amount have been purchased during the year. So, in both sources and uses of funds, an amount of ` 60,000 is to be shown. Similarly, the amount received from sale of fixed assets is to be shown as a source.
Change in Net worth: While comparing the figures of two successive balance sheets, we have to take into account the outgo on account of dividend or withdrawal of capital. For example: If the company has reduced its equity capital through buy back of shares, it may not be reflected correctly as the profit has been added to the reserves. Also, withdrawal of profits through dividend is to be shown as a use of funds while the entire net profit should be shown as a source of funds.

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JAIIB AFM Module B Unit 5 CASH FLOW AND FUNDS FLOW (Ambitious Baba)