What is the Cash Flow Statement?
The cash flow statement details a company's monetary inflow and outflow over a specific time frame. It's one of the 3 most crucial income statements for running a small company and keeping track of money. The others are the balance sheet as well as the revenue section.
When you need to know how much money you possess in hand at any one moment, a statement of income isn't the way to go. The primary sections of a cash flow statement adjustments with new performa of a balance sheet are operating income, investment income, and financing income.
Cash Flow Statement Format
Funding-related cash inflows and reports produced by generally accepted accounting rules may contain a section detailing non-cash events. Earnings and expenditures are recognised on an accrual method of accounting at the time they are generated or spent rather than when the cash departs or enters a business's bank balances. The cash flow statement format inverts that monthly outlay, revealing available funds rather than total expenditures.
The cash flow statement format is shown in the below table.
Difference Between Cash Flow and Fund Flow Statements
Difference Between a Cash Flow and a Fund Flow Statement
The following are the critical difference between the cash flow statement and fund flow statement:
A Statement of Cash Flow is an accounting document detailing the inflow and outflow of cash into and out of business. A fund flow report, in contrast, is a declaration that depicts the analytical details of the many origins of money and their use in a bookkeeping period.
When comparing a company's financial health across the two balance sheet dates, a Statement of Cash Flow focuses on cash movement. At the same time, the Fund Flow Report analyses the movement of working capital. Retained earnings include a variety of resources, cash included.
The cash foundation of accounting is used for the Statement of Cash Flows. In contrast, the Fund Flow Statement operates on the accrual method of accounting.
The statement of cash flows is created for short-term financial management and decision-making. In contrast, the fund flow statement is more appropriate for long-term financial management & decision-making.
Cash Flow Analysis
Cash Flow Analysis
Working capital, or the funds available to run operations and settle transactions, is calculated through a cash flow analysis for a given company. This can be determined by subtracting the current liabilities from the current assets (funds and short-term investments such as notes receivable). Preparing to operate, invest, and financial statements of cash flows is the first step in conducting a cash flow analysis. The finance department typically utilises an accounting system to produce these reports.
By analysing your company's cash flow, you can determine if it has the resources to remain profitable in the long run. Consistent positive cash flow is frequently a symbol of bright spots, while persistent negative cash flow could indeed signal the possibility of insolvency.
Reasons to Choose Indirect Method of Cash Flow Statement
Indirect Method over the Direct Method in Cash Flow
To calculate working capital using the indirect technique, you must first examine the entries on your financial statements and then invert some of those. You need to deliberately reverse your financial report to remove entries that don't reflect a change in cash balances. The cash flow statement is based upon the cash basis of accounting. This one is far less complicated than the direct technique, making it a popular choice amongst small enterprises. If you choose the indirect approach, you won't need to double-check your claims against the direct approach to ensure they match up.
The indirect approach uses a statement of cash flows and makes adjustments for non-cash items to use an accrual approach to cash flow from operating activities. Due to the prevalence of accrual accounting in more prominent organisations, the indirect technique is often used.
The direct technique requires a detailed accounting of all financial outflows, which is both labour-intensive and time-consuming, making the Indirect method of cash flow statement the more practical and popular choice.
Conclusion
A business's health, profitability, and long-term viability may be gauged with a cash flow statement. To find out whether a business has enough cash on hand to cover its current obligations, use the CFS. To better plan for the future, a corporation might employ a cash flow statement (CFS). CFS is a good indicator of a company's financial health for shareholders because more cash on hand is always a good sign. That said, it's not an ironclad regulation. A company's expansion plans may hurt its cash flow.
FAQs on Cash Flow Statement Format: A Complete Guide
1. What is a Cash Flow Statement and what is its primary objective as per Accounting Standard 3 (Revised)?
A Cash Flow Statement is a financial statement that summarises the movement of cash and cash equivalents into and out of a company during a specific accounting period. Its primary objective is to provide detailed information about a company's cash receipts and cash payments, classified under three main activities: Operating, Investing, and Financing. This helps stakeholders assess the company's ability to generate cash, meet its obligations, and fund its operations.
2. What are the three main activities classified in the standard format of a Cash Flow Statement?
The Cash Flow Statement format, according to AS-3 (Revised), categorises all cash transactions into three main activities:
- Cash Flow from Operating Activities: These are the principal revenue-producing activities of the enterprise. Examples include cash received from the sale of goods and cash paid to suppliers.
- Cash Flow from Investing Activities: These include the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Examples include the purchase of machinery or sale of investments.
- Cash Flow from Financing Activities: These are activities that result in changes in the size and composition of the owner's capital and borrowings of the company. Examples include issuing shares or repaying a long-term loan.
3. How are 'Cash and Cash Equivalents' defined in the context of a Cash Flow Statement?
In the context of a Cash Flow Statement, 'Cash' and 'Cash Equivalents' include more than just physical currency. The term comprises:
- Cash in Hand: Physical currency and coins held by the company.
- Demand Deposits with Banks: Money held in current or savings accounts that can be withdrawn at any time without prior notice.
- Cash Equivalents: These are short-term, highly liquid investments that are readily convertible into a known amount of cash and are subject to an insignificant risk of changes in value. An example is a treasury bill with a maturity of three months or less from the date of acquisition.
4. Why can a highly profitable company, as shown on its Income Statement, still face a cash shortage?
This is a common scenario and highlights the importance of the Cash Flow Statement. A company can be profitable on paper but have negative cash flow due to several reasons:
- Aggressive Credit Sales: A large volume of sales made on credit increases revenue and profit but does not generate immediate cash. If customers (debtors) delay payments, the company's cash position suffers.
- Heavy Capital Expenditure: The company might be investing heavily in new machinery, buildings, or other fixed assets, which uses up significant cash.
- Debt Repayment: A large portion of cash may be used to repay loans (principal amount), which is a financing activity and not an expense in the Income Statement.
- Inventory Buildup: Purchasing a large amount of inventory requires cash outflow, but the cost is only recognised in the Income Statement when the goods are sold.
Thus, profit is an accounting concept, while cash is the actual liquid resource available to the business.
5. How does an investor use the Cash Flow Statement differently from the Income Statement for analysis?
While both statements are crucial, they offer different perspectives:
- The Income Statement shows a company's profitability over a period by matching revenues with expenses, including non-cash items like depreciation. It answers, "Is the company making a profit?"
- The Cash Flow Statement shows a company's liquidity and solvency. It focuses solely on the actual movement of cash, stripping away accrual accounting conventions. It answers, "Where did the company's cash come from, and where did it go?"
An investor uses the CFS to verify the quality of earnings (are profits converting to cash?), assess the ability to pay dividends, and understand the company's real financial health beyond accounting profits.
6. Why are non-cash items like depreciation and amortisation added back to net profit when preparing the Cash Flow Statement?
When calculating Cash Flow from Operating Activities using the indirect method, we start with Net Profit as per the Profit & Loss Account. This Net Profit was calculated after deducting non-cash expenses like depreciation and amortisation. However, these expenses do not involve any actual outflow of cash. To reverse their effect and arrive at the actual cash generated from operations, these non-cash charges must be added back to the Net Profit. This adjustment helps reconcile the accrual-based net profit with the cash-based operational flow.
7. What are some limitations of relying solely on a Cash Flow Statement for financial analysis?
While powerful, the Cash Flow Statement has certain limitations:
- Doesn't show profitability: It only shows cash movements, not whether the company is profitable. A company can have positive cash flow from selling assets or taking loans, even while making operational losses.
- Ignores non-cash transactions: Important transactions like the purchase of assets on credit or the conversion of debentures into shares are not reflected, as no cash is involved.
- Historical in nature: It is based on past data and does not predict future cash flows.
- Not a substitute for other statements: It must be analysed alongside the Balance Sheet and Income Statement for a complete and accurate view of a company's financial position and performance.
8. How is the treatment of interest and dividends different across operating, investing, and financing activities for a non-financial company?
The treatment of interest and dividends is a key aspect of the Cash Flow Statement format and depends on the nature of the transaction:
- Interest Paid: Classified as a Financing Activity as it is a cost of obtaining finance (e.g., interest on loans or debentures).
- Interest Received: Classified as an Investing Activity as it is a return on investments made by the company (e.g., interest on fixed deposits or investments in debentures).
- Dividends Paid: Classified as a Financing Activity because it is a cost associated with raising owner's capital.
- Dividends Received: Classified as an Investing Activity as it represents a return on investments made in other companies' shares.
For a financial company like a bank, interest paid and received would typically be classified under Operating Activities as they are part of its main business operations.
