Cash flow Statement
Definition:
Cash flow is particularly important for businesses as it is the lifeblood that
keeps the company running. A cash flow statement shows the inflows and
outflows of cash from different business activities like operating, investing,
and financing activities. It gives an indication of the amount of cash receipt
and payment or disbursement during an accounting period in different
activities of an organization. This statement shows the causes of increase or
decrease in cash and the net change in cash position during a particular
period.
It is mandatory to prepare a cash flow statement along with other financial
statements. According to the Company Act of 2063, a public limited company
must prepare a cash flow statement annually 30 days prior to the annual
general meeting, while a private limited company should prepare it within 60
days from the end of the accounting period. A well-prepared cash flow
statement can help businesses plan and manage their finances better.
Importance:
The statement of cash flow is a vital financial statement that provides
information on the inflows and outflows of cash of a firm over a period of one
year. Here are some reasons why the cash flow statement is so important:
-
It helps to identify the sources from where cash inflows have come from in a
particular period, allowing a firm to better understand where their revenue
is coming from.
-
The statement shows the various activities where cash was utilized, giving
insights into how the company is spending its money.
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By planning cash in a systematic method, a firm can maintain proper matching
between cash inflows and outflows, which can help to avoid liquidity
problems.
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The statement can also show the efficiency of the firm in generating cash
inflows from its regular operations, indicating the company's financial
health.
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The cash flow statement reports the amount of cash used during the period in
various long-term investing activities such as purchasing fixed assets.
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It also reports the amount of cash received during the period through
various financing activities such as issuing shares, debentures, and raising
long-term loans.
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The statement helps in the appraisal of various capital investment programs
to determine their profitability and viability, allowing the firm to make
informed decisions about future investments.
DIFFERENCES BETWEEN CASH FLOW STATEMENT AND FUNDS FLOW STATEMENT
|
Cash Flow Statement |
Funds Flow Statement |
|
Reports inflows and outflows of cash and cash equivalents during a
period. |
Reports inflows and outflows of funds during a period. |
|
Focuses on the liquidity position of a company. |
Focuses on the changes in the long-term financial position of a
company. |
|
Includes operating activities, investing activities, and financing
activities. |
Includes changes in working capital, fixed assets, and long-term
funds. |
|
Shows the actual movement of cash in and out of the company. |
Does not show the actual movement of funds but instead shows the
sources and uses of funds. |
|
Provides information on a company's ability to generate cash from its
operations. |
Provides information on a company's ability to finance its long-term
operations and investments. |
|
Helps in analyzing a company's cash position and cash management. |
Helps in analyzing a company's long-term financing decisions and the
changes in its capital structure. |
PREPARATION OF CASH FLOW STATEMENT
To prepare a cash flow statement, a company must identify and analyze the
major activities that generate and use cash. Cash inflows are categorized as
sources of cash, while cash outflows are considered uses of cash. These
activities are classified into three categories: operating, investing, and
financing activities.
1.Cash flows from operating activities
2.Cash flows from investing activities
3.Cash flow from financing activities
Cash flow from operating activities:
Cash flow from operating activities is the cash generated or used in a
company's day-to-day operations. These activities are the primary sources of
cash for most companies. Cash inflows from operating activities include cash
received from sales and the collection of accounts receivable from customers.
Cash outflows from operating activities include cash paid for purchases,
payments to suppliers, employee salaries and benefits, rent, utilities,
interest and taxes. Essentially, operating cash flow reflects the cash
generated or used by a company's core business operations.
Cash flows from operating activities could be determined by using two methods.
Direct and indirect method:
1.Cash flow from operating activities under direct method
When preparing the cash flow statement using the direct method, only those
items from the income statement that directly result in the flow of cash are
considered. This means that non-cash expenses like depreciation and
amortization are ignored. Additionally, changes in some components of current
assets and liabilities, except for cash, are taken into account as they affect
cash inflows and outflows.
A.
Cash sales and collection from debtors
This statement is referring to cash flows from operating activities,
specifically the portion related to cash inflows and outflows from customers.
It includes cash received from sales, as well as any changes in the amounts
owed to the company by customers (debtors) and any bills receivable.
B.
Cash purchases and payment to suppliers
This statement refers to the cash inflows and outflows associated with the
purchase of raw materials, or the cost of goods sold. It involves adjusting
changes in creditors and bills payable to the amount of raw materials
purchased or cost of goods sold.
C.
Payment to employees and other operating expenses
This statement refers to the cash outflows associated with running the
business, such as paying for wages, expenses, insurance, and other operating
costs.
D.
Payment for interest and taxes
This statement is referring to the cash flows from operating activities,
specifically the portion related to cash outflows resulting from interest and
taxes paid. It also includes any changes in the outstanding amounts of
interest and taxes.
E.
Cash from extra-ordinary activities
This statement is referring to the cash flows from financing and investing
activities, specifically related to short-term investments and financing. It
includes all the cash inflows and outflows associated with short-term bank
loans, bank overdrafts, and marketable securities.
2.Cash flows from operating activities under indirect method
In simpler terms, the indirect method is a way to determine the cash flow from operating activities by first calculating the funds from operations. This is done by adjusting the net income by adding back non-cash expenses and deducting non-operating incomes and expenses. The resulting figure is then further adjusted by changes in current assets and liabilities, other than cash, to arrive at the cash flows from operating activities. In short, it involves making a series of adjustments to the net income to arrive at the actual cash generated or used by the company's operations.
Cash flow from investing activities:
Investing activities involve transactions related to long-term assets or investments. Cash inflows from investing activities occur when the company receives cash from selling fixed assets or investments, while cash outflows occur when the company pays cash for the purchase of fixed assets or investments. Simply put, investing activities are focused on buying or selling long-term assets or investments, and the resulting cash flows are categorized as either inflows or outflows.