Overview of Cash Flow Statement
A cash flow statement is a financial statement that exhibits the flow of incoming and outgoing cash in an enterprise. This statement is used to assess the ability to generate and utilize cash by assessing business gains from continuous progress and external sources for cash inflow as well as a cash outflow in terms of payments made and other input charges in the business. In short, a cash flow statement records the cash flow in a business.
How do you Classify Cash Flow Statements?
Cash flow statements can be classified into the following categories:
Cash Flow Generated from Operating Activities: activities that generate significant revenue
Cash Flow from Investing Activities: acquisitions and disposals of long term assets and investments
Cash Flow from Financing Activities: activities that result in changing of size, composition and borrowing activities of a firm from other sources
What are the Objectives of Cash Flow Statements?
The cash flow statement assesses net changes in both cash and cash equivalent thus helping in the assessment of income generated through operations, financing, investing and other activities. It helps a business firm to formulate a budget plan and associated policies by assessing the cash flow statement. It also helps in managing cash efficiently.
How to Calculate Cash Flow Statements?
A cash flow statement is calculated by using two main methods: direct method and indirect method. It is important to make adjustments in the net income of a firm by adding or deducting differences in expenses, revenue, credit transactions and other non-cash things as they are evaluated in the income statement and balance sheet.
Direct Method
In the direct method of calculation, employee benefits expenses paid, cash received from trade receivables, etc., are transformed into a cash basis as items are reported on accrual data in the statement.
Indirect Method
The indirect method of cash flow statement calculation is based on the amount of net profit and loss. This includes the statements of various operational activities of a firm. It is also calculated on an accrual basis, thus, taking non-operating items into account such as interest paid, the goodwill that is written off, depreciation, etc.
Advantages
A cash flow statement helps a business owner assess net assets.
It helps in evaluating the cash-generating capability of a firm.
Aids in planning policies for profit-maximizing.
Understanding and assessing the cash flow of a firm helps in optimizing profit and sustainability.
Helps investors get an idea and judge the risk of investing in the firm.
Helps creditors understand a firm's resources in terms of liquidity and other assets as well as plan a budget for the firm's operational budget and other expenses and debts.
Limitations
Although there are huge advantages that a cash flow statement offers, there are some limitations too.
It is mostly based on secondary data
It does not take non-cash transactions into account
It does not adhere to the fundamental accounting principles
It is not a substitute for the income statement of a business
It is not totally useful in gauging the profitability of a business.
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FAQs on Cash Flow Statement: Preparation and Use
1. How to Make a Cash Flow Statement?
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?
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?
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 of net changes in cash flow.
4. What is cash flow?
In simple terms, cash flow is the money or capital incoming or outgoing of a business firm. A cash flow statement is the balance of credit that stays at hand for making payments and investments if any to keep the business running.
5. What is the difference between net income and cash flow statements?
Net income refers to the amount of capital that a business makes after deducting costs, allowances, and taxes. In simple terms, it is what a firm has left after making payments and covering other expenses.
Cash flow is the net income to which non-cash transactions, credit, expenses, and revenue are added or subtracted from one period to the next.
6. Why is a cash flow statement important?
A cash flow statement shows the outstanding money that is available to the business firm for using and making payments according to the needs of the business owners to keep the business running.
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7. Can cash flow be negative?
Cash flow can be negative which means a business is not generating revenue, therefore, business owners have to resort to borrowing, loaning, mortgaging assets to create funds and pay interests.
8. Does depreciation have an impact on cash flow?
Depreciation does not have an immediate effect on cash flow but it can absorb some of the taxable income as it shows its impact on the evaluation of a business over a long period of time.
