Cash Flow and Funds Flow
(Where Did the Cash Come From? Where Did It Go? — The Money Trail!)
A company can show ₹10 crore PROFIT on paper but have ZERO cash in the bank! How? Because profit is on accrual basis, but cash is REAL money. The Cash Flow Statement tracks the ACTUAL movement of cash — from operations, investments, and financing. This chapter covers both Cash Flow (mandatory) and Funds Flow (optional but useful for bankers).
Banky Discovers: Profit ≠ Cash! 💸
A borrower shows ₹10 crore profit but can’t repay a ₹50 lakh EMI. Banky is confused. His manager says: “Check the Cash Flow Statement! The company sold goods on CREDIT (profit on paper) but hasn’t collected the CASH yet. Profit is accounting. Cash is REAL!”
The Full Chapter — Follow the Money!
📖 Part 1 — 3 Types of Cash Flow Activities (OIF)
All cash movements are grouped into 3 categories:
1. OPERATING Activities 🏭: Cash from the main business — selling goods, receiving payments, paying suppliers, paying salaries, paying taxes. The DAY-TO-DAY revenue activities. This is the MOST important — it shows if the core business generates enough cash. Key indicator: can the company repay loans, pay dividends, and reinvest WITHOUT borrowing?
2. INVESTING Activities 🏗️: Cash from buying/selling LONG-TERM assets — purchasing machinery, selling a building, buying investments, selling investments. NOT the daily business — these are BIG, strategic decisions. Cash outflow here = the company is INVESTING for the future.
3. FINANCING Activities 🏦: Cash from raising/repaying CAPITAL — issuing shares, taking loans, repaying loans, paying dividends, buying back shares. This shows how the company is FUNDED — by owners (equity) or by lenders (debt).
Net Cash Flow = Operating (A) + Investing (B) + Financing (C) − Interest & Taxes.
📋 Part 2 — Direct vs Indirect Method (Ind AS-7)
Ind AS-7 allows TWO methods for reporting operating cash flows:
Direct Method: Show the ACTUAL cash receipts and payments. “We received ₹50L from customers, paid ₹30L to suppliers, paid ₹10L salaries.” Easier to understand but harder to prepare.
Indirect Method: Start with NET PROFIT and ADJUST for non-cash items. “Net profit ₹15L + Depreciation ₹5L (add back — it’s non-cash!) − Increase in receivables ₹3L (cash stuck!) + Decrease in payables ₹2L.” More commonly used in practice.
Key adjustments in indirect method: ADD back: depreciation, losses on sale of assets. SUBTRACT: gains on sale of assets. Increase in current assets (other than cash) = cash USED. Increase in current liabilities = cash GENERATED.
Important: Loan repayment includes interest (operating) + principal (financing) — a single payment split into TWO activities! Cash equivalents = short-term, highly liquid investments readily convertible to cash.
💰 Part 3 — Funds Flow Statement (5 Differences from Cash Flow)
Funds Flow compares TWO balance sheets to find: where did ADDITIONAL funds come from (sources) and where were they used (applications)?
Sources of Funds: Increase in liabilities side (more equity, more loans, more reserves) OR decrease in assets side (sold machinery, reduced inventory).
Uses of Funds: Increase in assets side (bought machinery, more inventory, more receivables) OR decrease in liabilities side (repaid loans, reduced capital).
Bankers classify into Long-Term and Short-Term sources/uses to check if long-term funds are being diverted for short-term uses (a RED FLAG!).
| # | Cash Flow Statement | Funds Flow Statement |
|---|---|---|
| 1 | MANDATORY (part of financial statements) | NOT mandatory |
| 2 | Segregated into O-I-F activities | No such segregation |
| 3 | Determines CASH position at end | Determines WORKING CAPITAL changes |
| 4 | Uses CASH basis | Uses ACCRUAL basis |
| 5 | Assesses LIQUIDITY | Assesses LONG-TERM financial strategy |
Exam-Ready Points
🎯 Must Remember!
- 3 Activities (OIF): Operating (daily business), Investing (long-term assets), Financing (capital/loans).
- Operating: Purchase/sale of goods, salaries, taxes, interest, rent — revenue-producing activities.
- Investing: Buy/sell machinery, buy/sell investments. Disposal of machinery = Investing, NOT operating!
- Financing: Issue shares, take loans, repay loans, pay dividends, buy back shares.
- Cash equivalents: Short-term, highly liquid, readily convertible, insignificant risk of value change.
- Profit ≠ Cash: Profit includes credit sales and non-cash items. Cash flow shows REAL money movement.
- AS-3 / Ind AS-7: Govern cash flow statement preparation. Part of mandatory financial statements.
- Direct method: Show actual cash receipts/payments. Indirect: Start with profit, adjust for non-cash items.
- Indirect adjustments: ADD depreciation (non-cash expense). SUBTRACT profit on asset sale. ADD loss on sale.
- Increase in current assets (non-cash) = cash USED. Increase in current liabilities = cash GENERATED.
- Loan repayment: Interest → Operating. Principal → Financing. One payment, TWO categories!
- Cash Flow = mandatory, cash basis, liquidity. Funds Flow = NOT mandatory, accrual, working capital.
- Funds Flow: Source = increase in liabilities/decrease in assets. Use = increase in assets/decrease in liabilities.
- Bankers check: Long-term funds diverted to short-term uses = RED FLAG in Funds Flow analysis.
- Sale of manufactured goods = Operating activity (not investing!). Sale of MACHINERY = Investing.
- Issue of fresh capital = Financing activity. Buyback of shares = also Financing.
- Increase in receivables = Use of funds (source for Funds Flow). Increase in current liabilities = Source of funds.
📝 Past Exam Questions
Memory Tricks
🧠 Trick 1
I = Investing 🏗️ (buying new kitchen)
F = Financing 🏦 (borrowing to buy)
“OIF = Our Income Flow!”
🧠 Trick 2
PROFIT on paper ✅
CASH in hand? ❌ ZERO!
Depreciation? EXPENSE on paper ✅
CASH paid? ❌ ZERO!”
🧠 Trick 3
ADD back depreciation (+)
Working capital increase? SUBTRACT (−)
Working capital decrease? ADD (+)
= Operating Cash Flow!”
🧠 Trick 4
Funds Flow = OPTIONAL 📝
Cash = LIQUIDITY 💧
Funds = STRATEGY 🎯
Cash = CASH basis | Funds = ACCRUAL”
🧠 Trick 5
(someone gave us money!)
Asset UP ⬆️ = USE 📦
(we spent money on something!)
Flip for decreases!”
🧠 Trick 6
Sell MACHINE = Investing 🏗️
Sell SHARES = Financing 🏦
What you SELL determines the category!”
🧠 Trick 7
Interest → OPERATING 🍳
Principal → FINANCING 🏦
One payment, TWO activities!”
🧠 Trick 8
SHORT-TERM purposes? 🚩
= DIVERSION of funds!
Check Funds Flow Statement!
Bankers catch this!”
Last-Minute Flash Cards
⚡ Module B • Chapter 5 (Unit 16) Done!
- 3 Activities (OIF): Operating (daily), Investing (assets), Financing (capital/loans). Net = O + I + F.
- Profit ≠ Cash: Profit includes credit sales & non-cash items. Cash Flow shows REAL money.
- Direct vs Indirect: Direct = actual cash. Indirect = profit ± adjustments. Indirect is more common.
- AS-3/Ind AS-7: Mandatory. Must show O-I-F separately. Cash equivalents = short-term liquid investments.
- Cash vs Funds Flow: Cash = mandatory/cash/liquidity. Funds = optional/accrual/working capital.
- Funds Flow: Liability ↑ or Asset ↓ = Source. Asset ↑ or Liability ↓ = Use. Bankers check LT→ST diversion.
Banky says: “OIF = Our Income Flow! Operating = daily cooking! Investing = buying kitchen! Financing = borrowing! Profit ≠ Cash! Now I can follow the money trail!” 🎉💸
Next: Chapter 17 — Final Accounts of BANKING Companies (the BANK’s own financial statements)! 💪