A cash flow statement is a statement that comprises the cash inflows and also outflows of the company operations. Also, it shows the company’s ability to generate cash and clear its debt obligations. Therefore, you can analyse the reasons behind the change in a company’s financial position.
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What is Cash Flow Statement?
A cash flow statement (CFS) is also an essential tool used to manage finances by tracking the cash flow of an organisation. Also, this statement is one of the three financial reports (with the income statement and balance sheet) that helps in determining the company’s performance. Thus, the CFS helps make a cash forecast for short term planning.
A cash flow statement (CFS) is a financial statement that shows the inflows and also outflows of cash and cash equivalents of a company. Also, the cash inflows come from operating, investing, and financial activities. Further, the cash outflows are the expenses paid for business activities and investments. Thus, this information is helpful for the management to make decisions for regulating the business operations.
Additionally, a cash flow statement measures how well a company manages its cash position. In other words, it shows the company’s ability to generate cash to pay its debt obligations and fund its operating expenses. Therefore, the CFS is an important statement as it helps the investors to analyse the company’s financial position. Moreover, it can be helpful for making better-informed decisions about their investments.
Importance of a Cash Flow Statement
It is essential to have sufficient cash for any business to be successful. The following is the importance of a cash flow statement –
- Details about Outflows: A cash flow statement also helps understand the company’s position to make principal payments to its creditors. Also, it shows detailed transactions which are not recorded in cash in other financial statements, like the purchase of inventory, extending credit to customers, buying capital equipment, etc.
- Maintaining Optimal Cash Balance: A CFS helps analyse and also maintain an optimal cash level in hand. It helps to determine whether excess cash is lying idle or if there is a shortage of funds. Also, if excess cash is lying idle, the business can use it to invest in shares or buy inventory. Subsequently, if there is a shortage of funds, the company can look for sources to borrow money to keep the business running smoothly.
- Focuses on Generating Cash: Profit is a critical factor for the growth of the company, and also this comes from generating cash. However, there are several other ways to generate cash. For instance, when a company pays less to acquire equipment, it pays less and generates cash.
- Helpful for Short Term Planning: A cash flow statement is also helpful for short term planning to meet various obligations. Hence, businesses must always have a sufficient amount of cash to fulfil their upcoming payments. Also, the CFS helps the financial manager analyse the past transactions data to make a cash flow projection for immediate future planning. For instance, the previous cash flow statements help to make decisions in forecasting the cash deficit the company will face after paying off the debt obligations or establishing a cash surplus to request credit from banks.
How to Prepare a Cash Flow Statement?
There are two methods to prepare a cash flow statement, namely the direct method and also indirect method –
Direct method
The direct method uses the gross cash payments and receipts, including the cash paid to suppliers, cash receipts from customers and also cash paid out as salaries. In simple words, this method only measures the cash received and paid out due to the company’s operating activities. The direct method is also known as the income statement method. Moreover, this method is easier for small businesses as they use a cash basis accounting method. However, it may be time-consuming as it must be reconciled with the income statement.
The following is an example for a cash flow statement under direct method for XYZ company for the financial year 2020-2021
| Particulars | Amount (Rs.) | Amount (Rs.) |
| Cash flows from Operating Activities: | ||
| Cash received from clients | 51300 | |
| Cash paid for the merchandise | -15000 | |
| Cash paid to employees | -10000 | |
| Cash paid for interest | -500 | |
| Cash paid for income taxes | -1500 | |
| Net cash provided by operating activities | 24300 | |
| Cash flows from investing activities: | ||
| Purchase of property and equipment | -101000 | |
| Cash receipts from property sale | 50000 | |
| Net cash used in investing activities | -51000 | |
| Cash flows from financing activities: | ||
| Payments on the line of credit | 10000 | |
| Proceed from long-term debt | 99500 | |
| Payments on long-term debt | 0 | |
| Net cash provided (used) in financing activities | 109500 | |
| Net increase (decrease) in cash | 58500 | |
| Beginning cash balance | ||
| Ending cash balance for FY 20-21 | 58500 |
Indirect method
The indirect method uses the accrual accounting information where the revenue and expenses are included when the transaction is made rather than when money is received. Therefore, this method always starts with net income taken from the income statement. Afterwards, the net income is adjusted for any changes in assets or liabilities account on the balance sheet. Also, adjustments for non-operating expenses like accounts payable, accounts receivable, inventory, depreciation, etc., are made to determine the cash for the company’s operating expenses. These expenses do not directly affect the cash flow but must be included in the cash flow statement. Moreover, most companies use this method to prepare their cash flow statement.
The following is an example of a cash flow statement under the indirect method for ABC company for the financial year 2020-2021
| Particulars | Amount (Rs.) | Amount (Rs.) |
| Cash flows from operating activities: | ||
| Net income | 1000000 | |
| Add (subtract) non-cash effects on operating revenue | ||
| Depreciation expense | 120000 | |
| Income from the sale of land | -150000 | |
| Increase in accounts payable | -250000 | |
| Decrease in inventory | 40000 | |
| Increase in accounts payable | 70000 | |
| Decrease in wages payable | -30000 | -200000 |
| Net cash generated by operating activities | 800000 | |
| Cash flows from investing activities: | ||
| Sale of land | 750000 | |
| Purchase of equipment | -150000 | |
| Net cash generated by investing activities | 600000 | |
| Cash flows from financing activities: | ||
| Profits from issuing stock | 80000 | |
| Common stock dividends | -50000 | |
| Repayment of long-term loans | -900000 | |
| Net cash generated by financing activities | -870000 | |
| Net increase in cash | 530000 | |
| Cash balance at April 1, 2020 | 170000 | |
| Cash balance at March 31, 2021 | 700000 | |
| Non-cash financing/ investing activities: | ||
| Issued preferred stock or building | 300000 |
Activities under a Cash Flow Statement
The following are the three activity sections under the cash flow statement: operating, financing, and investing.
Operating
Operating activity refers to the primary business activities that also generate revenue for the money spent on producing a product or service. The following are operational business activities that include
- Receipts from the sale of goods or also services
- Interest payments
- Income tax payments
- Salary and also wages of employees
- Payments to suppliers for goods or also services used in production
- Rent payment
- Any other type of operating expense
Thus, this section in the cash flow statement begins with the net earnings, which gives an estimate of the company’s profitability. Afterwards, it lists the non-cash items involved in operational activities and converts them into cash items. Therefore, a company’s cash flow statement should be positive for its adequate operational activities. However, a negative cash flow may be difficult for a company to manage its daily operations.
Investing
Investing activity also refers to any sources or uses of cash from a company’s investment. In other words, it includes the acquisition and disposal of non-current assets and other investments not included in cash equivalents. The following are investing activities that include
- Cash flows associated with buying or also selling of an asset
- Investing in fixed deposits, mutual funds and also stock market
- Payments related to mergers and also acquisitions
- Other non-current assets or financial assets
Thus, this section usually includes the capital expenditure that the company incurs to invest in fixed assets. Also, an increase in capital expenditure (CapEx) means the company is investing in future operations. Furthermore, this shows a decrease or negative cash flow. However, this is not an indicator of poor performance because this investment can lead to high capital growth.
Financing
Financing activity refers to any changes in the size or composition of equity capital and also borrowings of the company. In other words, it includes the transactions related to debt, equity and dividends. The following are financing activity that include
- Borrowing and also repaying bank loans
- Raising capital in the form of equity
- Issuing bonds to the public for raising capital
- Paying dividends
In this section, the incoming transactions are when the company raises capital, and outgoing cash is when a dividend is paid or a loan is repaid.
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