Cash Flow Statement: The hour need for every business

Hey there! TallyDekho is here to educate the readers, one of the most popular financial statements, Cash Flow Statement showcasing the cash inflows and outflows from the business. In this article, we’ll discuss the working of the cash flow statement in detail and how useful it is for various business parties.

In every business organization whether small-scale or large-scale, the inflow and outflow of cash take place. Cash is considered as the heart and soul for any business and is known as the pivot of all the business operations. Therefore, the need for a financial statement arises that summarizes all the cash transactions happening in the concern. Such a statement is referred to as the cash flow statement in accounting terms.

In other words, a financial statement that summarizes the inflow and outflow of cash and cash equivalents in the business concern is known as the cash flow statement. It is also known as the statement of cash flows that reveals the short-term viability of the business. Also, this statement is a complementary statement to Balance Sheet and Profit & Loss Statement and is considered a very vital part in financial analysis. However, people often get confused between cash flow and fund flow. In one of the previous articles, we’ve discussed the fund flow statement as well. Both terms have a difference.

• A cash flow statement indicates the changes in the cash position whereas a fund flow statement showcases the changes in the working capital of the concern.
• Also, CFS is structured on the cash basis of accounting, on the other hand, FFS is structured on the accrual basis of accounting.

Methods of calculating cash flow

Basically, there are two methods of calculating cash flows:

Direct Cash Flow Method

Under this method, all the cash receipts and payments made constituting cash receipts from customers and cash paid to suppliers are added up. In this statement, the beginning and ending balances are used for various accounts.

Indirect Cash Flow Method

The indirect method of calculating cash flow constitutes three major activities for preparing CFS namely operating, investing and financing activities.

Under this method, all the non-cash items are adjusted in the earnings before interest and taxes (EBIT) as there are some items previously added in the net income calculated on the accrual basis. So, such non-cash items are required to be adjusted to calculate actual cash income. However, the indirect method of calculating cash flow is quite popular.

Structure of the cash flow statement

As you can see in the CFS specimen provided above, the entire cash flow statement is divided into three major parts namely:

• Cash flow from operating activities

Operating activities are all those activities that are directly related to the production and sales of the company products. Activities like purchasing raw materials, an increase in inventory, payment made to supplier and cash receipts from debtors all come under this head.

However, there are certain other non-cash items like depreciation, deferred tax, writing off preliminary expenses, etc which are added back to ascertain the actual cash inflow/outflow from operating activities.

• Cash flow from investing activities

Cash received/paid for sale/purchase of assets like land, equipment, building, etc comes under this head.

• Cash flow from financing activities

Financing activities include the inflow of cash from activities like the issue of shares and debentures and outflow of cash to shareholders in the form of payment of dividends. Also, these activities have a long-term impact on financing decisions.

Uses of Cash Flow Statement

It is pretty clear now that no business can know the exact cash position of the concern without preparing a cash flow statement. So, let us see its uses in the business field:

Showcases the actual cash position of the company

The primary purpose of preparing a cash flow statement is to ascertain the actual cash position of the company so that the financial decisions could be taken as and when required.

Assists the company in making accurate predictions

When the business has a clear view of the cash inflows and outflows, the future forecasting becomes easy. With the exact figures, the rate of accuracy becomes higher.

Checks the short-term viability of the business

As the cash flow statement calculates the cash position of the business, it helps the concern in checking the short-term viability of the business. It checks if the business is capable of meeting the obligations on time.

Provides a detailed summary of all activities

The best thing about the cash flow statement is that it provides a detailed summary of all the activities related to operations, investment and financing. Thus, it gives a complete financial outlook in a single statement.

Enables the firm to plan financial operations

As a cash flow statement gives an overall idea of all the cash inflows and outflows in the business, so it, therefore, enables the firm to plan the financial operations of the concern accordingly.

Thus, it is very clear that the cash flow statement is a valuable instrument for measuring liquidity and profitability of the company in the short as well as long run. Stay connected for more interesting articles. Feel free to share your feedback.