Hello! Welcome to our final lesson on the Cash Flow Statement.
In our last session, you learned how to construct a complete Cash Flow Statement by integrating the calculations for operating, investing, and financing activities. We followed a systematic process that brings together all the information from the balance sheet and additional notes.
Today, we will focus on the final, crucial step of this process. The learning outcome for this lesson is to verify the final result of the Cash Flow Statement with the change in Cash and Cash Equivalents. This step is the "moment of truth" where you confirm that your entire statement is arithmetically correct. Mastering this will give you the confidence to know your answer is right in an exam setting.
1. The Principle of Reconciliation
The entire purpose of the Cash Flow Statement (CFS) is to explain the reason for the change in a company's cash balance over a period. Therefore, the logical conclusion of the CFS is to prove that the cash flows you calculated from all activities precisely match this change.
This final section of the statement is a reconciliation that follows a simple, powerful formula:
Opening Balance of Cash & Cash Equivalents
+ Net Increase/(Decrease) in Cash & Cash Equivalents (from all three activities)
= Closing Balance of Cash & Cash Equivalents
The opening and closing balances are taken directly from the comparative Balance Sheets. If the equation holds true, your statement is verified.
What are "Cash and Cash Equivalents"?
Before we can verify the balances, we must be certain about what to include. As per Accounting Standard-3 (AS-3), "Cash and Cash Equivalents" include:
- Cash: Cash in hand and demand deposits with banks.
- Cash Equivalents: Short-term, highly liquid investments that are readily convertible into a known amount of cash and have an insignificant risk of a change in value. Typically, these are investments with a maturity of three months or less from the date of acquisition.
To understand this better, let's look at the formal definition and some examples.
This resource from Aspirations Institute provides a clear definition of Cash and Cash Equivalents as per AS-3 and lists examples of what to include.
Please read the section under the heading 'Meaning' and the definitions for 'Cash' and 'Cash equivalents'. This will clarify which items from the Balance Sheet you need to group together for the final verification step.
Key items to remember:
- Included: Cash in Hand, Cash at Bank, Cheques/Drafts on Hand, Marketable Securities, and Current Investments (if they meet the criteria of being short-term and highly liquid).
- Not Included: Bank Overdraft and Cash Credit are generally treated as Financing Activities (a form of short-term borrowing) and are not included in the opening/closing balance of cash for this verification step.
2. The Verification Process in Action
The final part of the Cash Flow Statement format is designed specifically for this verification. Let's see how it's structured.
Now, let's watch a short video that explains exactly how this final step works in practice.
Cash Flow Statement ( Indirect Method ) AS 3 | Class 12th | CA Intermediate | Accounts
This clip from Lavish Gupta's tutorial directly addresses our learning outcome. He explains how to perform the final check after calculating the cash flow from all three activities.
Watch the segment from 11:23 to 12:27. Focus on how the 'net increase/decrease in cash and cash equivalents' is combined with the opening balance to verify the closing balance given in the question.
To solidify this, let's walk through a solved problem where you can see the final numbers come together. The document below contains several examples. We will look at "Comprehensive Illustration 4".
This resource contains multiple solved problems. We will focus on one to see the verification step with actual figures.
Scroll down to 'Comprehensive Illustration 4' and examine the final section of the solved 'Cash Flow Statement'. Observe how the following values are used: Net Increase in Cash & Cash Equivalent: Nil Add: Cash & Cash Equivalent at the beginning of year: ₹3,000 (from the 2016 Balance Sheet) Cash & Cash Equivalent at the end of year: ₹3,000 (matches the 2017 Balance Sheet)
In this example, the total cash flow from all activities was zero. Therefore, the opening cash balance of ₹3,000 plus a net change of zero correctly equals the closing balance of ₹3,000. The statement is verified.
3. Another Perspective on Reconciliation
Hearing a concept explained in a different way can often deepen understanding. This next video provides a great visual walkthrough of the entire process, emphasizing how the CFS reconciles back to the Balance Sheet.
The CASH FLOW STATEMENT for BEGINNERS
The 'Accounting Stuff' channel provides a very clear, visual explanation of how the Cash Flow Statement links back to the Balance Sheet. This will reinforce what we've just learned.
Please watch these two key segments: 08:10 - 08:43: See how the opening and closing cash balances are first identified from the comparative Balance Sheet. 14:24 - 15:06: Watch the final reconciliation where the calculated 'net increase in cash' perfectly matches the movement identified in the first step. This confirms the accuracy of the statement.
Test your understanding!
A company's finished Cash Flow Statement shows the following totals:
- Net Cash from Operating Activities: ₹1,20,000
- Net Cash used in Investing Activities: (₹85,000)
- Net Cash from Financing Activities: ₹30,000
The comparative Balance Sheet shows that the 'Cash and Cash Equivalents' balance was ₹40,000 at the start of the year and ₹105,000 at the end of the year.
Based on this information, is the Cash Flow Statement arithmetically correct? Perform the verification.
Show answer
-
Calculate Net Increase/Decrease in Cash:
₹1,20,000 (Operating) - ₹85,000 (Investing) + ₹30,000 (Financing) = ₹65,000 (Net Increase) -
Perform the Reconciliation:
Opening Balance: ₹40,000
Add: Net Increase: ₹65,000
Expected Closing Balance: ₹105,000 -
Compare:
The expected closing balance (₹105,000) matches the actual closing balance from the Balance Sheet (₹105,000).
Conclusion: Yes, the Cash Flow Statement is arithmetically correct.
4. What to Do When It Doesn't Tally?
In an exam, discovering that your final numbers don't match can be stressful. But it's also a signal that something was missed. Here’s a quick troubleshooting checklist:
- Check Your Math: Start with the final addition. Did you correctly sum the net flows from the three activities? Did you add the opening balance correctly?
- Verify Signs: Go back through your statement. Did you use the correct signs? For example, a purchase of an asset is an outflow (negative), while the issue of shares is an inflow (positive). An increase in a current asset (like inventory) is a negative adjustment in operating activities.
- Review Ledger Accounts: If you prepared working notes (e.g., Fixed Asset A/c, Provision for Tax A/c), double-check your calculations, especially the balancing figures. A common error is miscalculating depreciation or the purchase/sale of an asset.
- Scan the Balance Sheet Again: Ensure every single item that changed from the opening to the closing balance sheet has been accounted for somewhere in your Cash Flow Statement or working notes. It's easy to overlook an item.
- Check Cash & Cash Equivalents Components: Did you correctly identify all parts of the opening and closing balances? For instance, did you remember to include 'Marketable Securities' along with 'Cash at Bank'? Did you incorrectly subtract a 'Bank Overdraft'?
Following this checklist systematically will almost always help you find the error.
Conclusion
Congratulations on completing the Cash Flow Statement module! You now have the full picture, from calculating each section to performing the final, all-important verification.
Key Takeaways:
- The final step of the Cash Flow Statement is to verify that the calculated net change in cash matches the change shown in the Balance Sheet.
- The verification formula is: Opening Cash + Net Change from CFS = Closing Cash.
- It's crucial to correctly identify all components of "Cash and Cash Equivalents" as defined by AS-3.
- This verification is a powerful self-checking tool that confirms the accuracy of your work.
Preview of the Next Lesson:
This lesson concludes our module on the Analysis of Financial Statements. We've now covered all the major tools and statements required for this part of your syllabus.
As planned, we will now shift our focus back to partnership accounting. In the next module, we will begin with the Dissolution of a Partnership Firm. Our first lesson will focus on distinguishing between the dissolution of a partnership and the dissolution of a partnership firm, and you'll learn how to prepare a Realization Account to begin the process of closing a firm's books.