Cash flow statement

Formally, the statement of cash flows explains the change in cash and cash equivalents (C&CE) between two balance-sheet dates, sorted into three activities.

Cash and cash equivalents means cash on hand and demand deposits, plus short-term, highly liquid investments readily convertible into known amounts of cash with insignificant risk of value change. In practice that means an original maturity of three months or less at acquisition: treasury bills, commercial paper, liquid funds. A 90-day T-bill qualifies. A 6-month fixed deposit doesn't. You'll use two consequences of this constantly:

• Moving money between cash and a cash equivalent, say by buying a 90-day T-bill, isn't a cash flow at all. It never appears in the statement.
• The bottom line ties to C&CE, which on an Indian Schedule III balance sheet is narrower than "all the money". TCS-style companies hold most of their war chest in "investments" and "bank balances other than C&CE" (deposits beyond three months, unpaid-dividend accounts, margin money). All of that is outside the CFS's definition of cash.

Why can the statement always be built from the other two plus a little detail? Start from the balance-sheet equation, Assets = Liabilities + Equity, and split assets into cash and everything else:

Cash + Non-cash assets = Liabilities + Equity
⇒ ΔCash = ΔLiabilities + ΔEquity − ΔNon-cash assets

Every rupee of cash movement is fully explained by changes in everything that isn't cash. The CFS is just this identity with the right-hand side sorted into three buckets by why the change happened. That's why the practice set has you derive a complete CFS from two balance sheets and an income statement. It's also why, in the statement-linkage capstone ahead, the three statements click shut into one loop.

The three sections: CFO, CFI, CFF

You sort by activity. Size and sign don't come into it. For every cash movement, ask: was this the business operating, investing in capacity, or dealing with its financiers?

Operating (CFO). Cash from the principal revenue-producing activities. That means collections from customers and payments to suppliers and employees. Rent and power count too. So do interest and taxes, subject to the section ahead on interest, dividends and tax. It tells you whether the core engine produces money.

Investing (CFI). Cash spent on or recovered from long-term assets and investments not held for trading. That covers PP&E purchases ("capex") and intangibles, disposal proceeds and business acquisitions net of cash acquired. Loans given to others count too, as do purchases and sales or maturities of investment securities. It tells you what management is planting for the future, and at what cost.

Financing (CFF). Cash exchanged with providers of capital. Think share issues and buybacks, borrowings raised and repaid, the principal element of lease payments, and dividends paid. Under Ind AS, interest paid goes here too. It tells you who funds the machine and what goes back to them.

What are the rules for classifying a cash flow?

Three placement rules prevent most classification errors:

1. Follow the asset's role, not its label. A delivery truck is CFI. Inventory is an operating asset, so it's CFO. Shares of another company are CFI, unless you're a securities dealer. Then they're your inventory and belong in CFO. Context decides.
2. Principal vs cost of money. Loan principal raised or repaid is CFF. The interest follows the standard-specific rules in the section ahead. Lease payments split: principal goes to CFF, and interest follows the interest rule. Under US GAAP, operating-lease payments stay wholly in CFO, a trap that same section covers in detail.
3. No cash, no line. Debentures converted to equity, a plant acquired on lease, shares issued to buy a company: these appear in none of the three sections. All three standards require separate disclosure. Skip that note and you can miss a company adding enormous leased capacity while "spending" nothing in CFI. Read the note. Always.

Classification examples: which section does each item go in?

A first classification reflex, before the standards nuances: