In financial accounting, a business form adopts several methods and techniques to record and represent its financial transactions of an accounting year accurately. Cash flow statement is one of such endeavours of a firm to maintain an accurate record of its all-cash inflow and outflow and their categorisation.
Would you like to learn about it in some detail? Read along to find more on this topic from below!
What is a Cash Flow Statement?
The cash flow statement definition explains that it is a financial statement which shows the incoming and outgoing cash and other cash equivalents of a business firm in a given period.
Notably, the cash inflow indicates the revenue a firm generates through its various operations and also from external sources of financing. On the other hand, cash outflow indicates the expenses that are incurred by an organisation to keep its trading operations actively running and also for repaying the external sources of finances.
As per the revised Accounting Standard-3, the preparation of cash flow statements and other financial statements is mandatory for all listed companies. Such a financial statement comes in handy for assessing the ability of a firm to generate money and use the same optimally. It also proves to be a useful tool for assessing a firm’s liquidity and solvency.
Notably, this financial statement is not the same as a balance sheet or an income statement. To elaborate, a statement of cash flow does not include any future cash transactions that are listed on credit. Hence, it can be said that cash is equivalent to net income here. Contrarily, both balance sheets and income statements include both cash sales and sales made on credit.
The inflow and outflow of both cash and its equivalent can be classified as -
Cash Flow Generated Through Operating Activities
It includes significant revenue-generating activities of a firm and other activities.
Cash Flow Originating From Financing Activities
It comprises those activities which alter the size and composition of capital and borrowings of a firm from other sources.
Cash Flow Resulting From Investing Activities
It consists of acquisitions and disposals of long-term assets and investments, which are not included in cash equivalent.
Check your progress: Classify these following financing activities under the header of cash inflow and cash outflow.
Payment of loans.
Issue of debenture in cash.
Payment of interest.
Securities premium received.
Issue of debentures in cash.
Premium paid on redemption of preference shares.
This table below will serve as an example of cash flow statement illustration-
Test Your Knowledge: Operating activities make up the primary source of revenue and expenses of a firm.Can you name a few items that comprise such operating activities?
Let’s check out the primary objectives of a cash flow statement–
To aid short-term financial planning.
It aims to facilitate efficient cash management.
To formulate sound business policies.
Formulation of a cash budget.
It helps to assess net changes in both cash and cash equivalent.
To assess income flow generated through operations, financing and investing, among others.
Advantages of Cash Flow Statement
These pointers below offer an overview of the significant advantages of cash flow statement –
This statement, along with other financial reports enables business owners to assess changes in net assets.
It helps to evaluate a firm’s ability to generate cash and its equivalent.
Proves useful in stabilising a firm’s money inflow and outflow to help optimise its profitability and sustainability.
It helps investors to gauge a company’s ability to generate cash from different sources and their ability to use it optimally. Also, it helps them to assess an organisation’s financial reliability.
Proves useful for creditors and helps them to compute how much liquid cash a company possesses and how efficient it is to pay for its operational expenses and other debts.
Although it comes in handy in several ways, there are certain limitations of which business owners should be aware.
Limitation of a Cash Flow Statement
Here are some limitations of a cash flow statement –
It is mostly based on secondary data.
It is mostly based on the historical cost principle.
It tends to ignore non-cash transactions.
Does not adhere to fundamental accounting principles.
Does not substitute the income statement.
It is not entirely useful in gauging the profitability of a business firm.
Is there any other limitation that you would like to add to this list?
Preparation of Cash Flow Statement
Typically, the cash flow of a firm is computed by changing and adjusting a few things in its net income. For instance, differences in expenses, credit transactions, revenue, etc. are either added to it or deducted from it.
Since non-cash items are evaluated with the help of net income and aggregate assets and liabilities, cash flow adjustments are essential. Usually, the income generated through operating activities can be determined with the help of Direct and Indirect methods.
Find out about these methods of cash flow statement in details from Vedantu’s free online classes and strengthen your fundamentals of cash flow significantly. Also, with the help of our compact study solutions and PDF downloads, you can gain valuable insight into various subject matters. You Will be able to improve your understanding to a great extent.
Download Vedantu App on your device now to benefit in these ways and much more!
1. How to Make a Cash Flow Statement?
Ans. Cash Flow statements can be prepared by employing two methods, namely, direct method and indirect method. In the case of the direct method, cash inflow and outflow are taken into account. On the other hand, in the indirect method cash-flow generating from operating activities are primarily taken into account.
2. What are the Types of Cash Flow Statements?
Ans. There are three types of cash flow statement activities – operating activities, financing activities and investing activities.
3. What is the Purpose of a Cash Flow Statement?
Ans. The purpose of a cash flow statement is to record both cash inflow and outflow of a firm and account for them accordingly. Also, it helps to formulate a cash budget and enables to assess net changes in cash flow.