Well, CFS is a statement that is prepared to know the CASH PROFITS or LOSSES for a year, using the net profit as per the P&L Acc. It also represents the increase or decrease in the liquid funds lying with the company (including cash & bank balance and liquid marketable securities).

1. First of all, we add back all the NON-CASH EXPENSES (eg. Depreciation) and subtract all the NON-CASH INCOMES (eg. Interest Receivable.) to/from the net profit as per P&L Acc.

2. Now, Increase or decrease in cash and cash equivalents may result due to 3 kinds of activities, namely OPERATING, INVESTING & FINANCING.

3. Operating Activities are the day to day operations of the business. And the cash effect of such operations is used to determine whether the operations of the business have resulted in increase or decrease of cash balance. For eg., We add the amount increase in payables (because of low outflow) and subtract the increase in receivables (because of low inflow). So, additions mean INFLOW and subtractions mean OUTFLOW.
After all the additions and subtractions, we arrive at a figure that represents the “Net Cash Flow Due To Operating Activities”.

4. Then come the Investing Activities. These represent the cash effect of the investments made or redeemed (including the amounts of interest). We subtract the amount of new investments made (because it results in outflow) and we add the amount of investments redeemed or the interest receivable (because it results in inflow). After all the additions and subtractions, we arrive at a figure that represents the “Net Cash Flow Due To Investing Activities”.

5. Now the 3rd kind of activity is the Financing Activity. This represents borrowing or repayment of funds (including interest). We add or subtract the amount of funds borrowed or repaid respectively. Now the resultant figure represents the “Net Cash Flow Due To Financing Activities”.

6. Then we sum up the Net cash flows from all the 3 activities and we arrive at the net increase or decrease in cash and cash equivalents. Adding in this, the opening balance of cash and cash equivalents (balance at the beginning of the year), we get the closing balance (balance at the end of the year).

P.S. you know you’ve prepared this statement correct if your closing balance tallies with that in the balance sheet. 🙂