Cash Flow Statement

  • Post last modified:13 July 2021
  • Reading time:8 mins read

What is Cash Flow Statement?

Cash Flow Statement as its name suggests takes into consideration only those transactions which are related to the movement of cash and all those dealings which affect the cash position of the concern. With the help of a cash flow statement, a finance manager can ensure that the business will have liquid assets for meeting day-to-day expenses.

Uses of Cash Flow Analysis

  1. Discloses the movement of cash
  2. Discloses success or failure of cash planning
  3. help in evaluating financial policies and cash position
  4. Providing information about funds available from operations
  5. Other uses of cash flow statement

Discloses the movement of cash

Cash flow statement discloses the picture of cash movement. The reason for the increase in and decrease for cash can be indicated by the cash flow statement. Cash flow analysis discloses the various reasons for low cash balance in spite of heavy operation profits or for heavy cash balance inspite of low profits.

Discloses success or failure of cash planning

With the help of comparing the projected cash flow analysis, the extent of success or failure of cash planning can be determined. The projected cash flow statement is compared with the actual cash flow statement and necessary remedial measures can be taken by the organisation.

Help in evaluating financial policies and cash position

Cash is the basis for all operations and hence a projected cash flow statement will enable the management to plan and co-ordinate the financial operations properly. The management can know how much cash is needed, from which source it will be derived, how much can be generated internally and how much could be obtained from outside.

Providing information about funds available from operations

Cash flow analysis provides information about funds that will be available from operations. This will help the management in determining policies regarding internal financial management, e.g. the possibility of repayment of long-term debt, dividend policies, planning replacement of plant and machinery, etc. In this way, cash flow analysis helps in managing internal financial sources.

Other uses of cash flow statement

Cash flow statement is a useful supplementary instrument. It discloses the volume as well as the speed at which the cash flows in the different segments of the business. This helps the management in knowing the amount of capital tied up in a particular segment of the business. The technique of cash flow analysis, when used in conjunction with ratio analysis, serves as a barometer in measuring the profitability and financial position of the business.

Preparation of Cash Flow Statement

A Cash Flow Statement is prepared to show the movements of cash between the closing dates of two Balance Sheets. It starts from the opening cash and ends with the closing balance of cash showing different sources from where cash was received and the manner in which it was utilized during the period for which the Cash Flow Statement is prepared.

Transactions affecting on Cash Inflows and Cash Outflows

The useful transactions resulting in cash inflows are :

  • Issue of shares
  • Issue of debentures
  • Sale of investments
  • Sale of assets
  • Cash from business operations

Cash outflows due to its application for various purpose such as :

  • Redemption of preference shares
  • Redemption of debentures
  • Purchase of investments
  • Purchase of assets
  • Cash Issues in business operations

Construction of Cash Flow Statement

While constructing the cash flow statement, following points are important :

  1. An increase of share capital, debentures and loans clearly mean that cash inflow took place due to additional issue of shares and debentures and obtaining further loans during the year.
  2. A decrease in current year figures of the liabilities will mean liquidation of liabilities and hence an application of cash.
  3. A comparison of non-current assets like land and buildings, plant and machinery, furniture, trade-investment, etc. will tell whether there had been increasing or decrease in cash or an item resulted in cash inflow or cash outflow.
  4. To calculate, how variations in noncurrent assets and liabilities generate oruse funds (cash) the following general rules are to be kept in mind.
  • Increase in Non-current liability=Cash Inflow
  • Decrease in Non-current liability=Cash Outflow
  • Increase in Non-current asset=Cash Outflow
  • Decrease in Non-current asset=Cash Inflow

Cash from Business Operations

The traditional Profit and Loss Account is based on certain accounting concepts and conventions such as accrual and matching principles according to which non-operating and non-cash items are also brought into it. Therefore, the net profit as shown by a traditional Profit and Loss Account cannot be equivalent to cash and as such, it needs certain adjustments to arrive at net cash inflow or cash losses due to business operations. The adjustments are required in respect of the non-operating and non-operating and non-cash items which do not affect the cash flows.

Limitations of Cash Flow Analysis

Following are the limitations of cash flow analysis :

  1. The cash balance as disclosed by the cash flow statement may not represent the real liquid position of the business since it can be easily influenced by postponing purchases and other payments.
  2. Cash flow statements cannot replace the Income Statement or the FundsFlow Statement Each of them has a separate function to perform.
  3. Cash flow statement cannot be equated with the Income Statement. an income Statement takes into account both cash as well as non-cash items and, therefore, net cash flow does not necessarily mean net income of the business.
  4. In the cash flow statement, the comparison of the original forecast with actual results highlights the trends of movement of cash which may otherwise go undetected.

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