Cash flow statement is little similar to fund flow statement. The fund flow statement is based on accrual basis. But cash flow statement is based on cash basis.
It reports only the cash transaction and it provides the information about the inflow and outflow of cash.
Cash flow statement reports cash inflow and outflow during the specific accounting period.
Cash flow statement can be divided into three activities. They are operating activities, investing activities and financing activities.
There are two methods to prepare cash flow statement.
They are direct method and indirect method.
Cash flow statement is one of the important tools of financial analysis.
The company or organization should be prepare cash flow statement along with profit and loss account and balance sheet at the ending of the financial year.
Importance of cash flow statement
The main importance of cash flow statement is given below:
1) We prepare cash flow statement on the basis of cash basis, not on accrual basis. So cash position of a company can be easily evaluate.
2) It helps to make plan coordinating investing properly.
3) It helps to plan repayment of loan, replace the fixed assets and other long terms financial planning.
4) It is very useful to external and internal users.
5) External users like creditors, bank, financial institutes etc provide loan after analyzing cash flow statement.
6) Internal users like management of the company can make the plan and take the decision from cash flow statement.
Objectives of cash flow statement
The main objectives of cash flow statement are as follows:
1) To provide the information about cash receipt and payment of a company during accounting period.
2) To provide information about cash and cash change position during the accounting period.
3) To provide information about operating activities, investing activities and financing activities.
4) To help the liquidation position of the company.
5) To locate the reason for variation in cash position.
6) To help the short term cash planning.
Users of cash flow statement
Generally, there are two main users of cash flow. They are inside users and outsider users. The insider users are management and outsider users are creditors and investors.
Managements take decision about new policy by analyzing the financial statements. Managements can draw the significant-conclusion and determine.
Cash flow statement helps them in different ways for knowing the financial position, profitability and capital structure.
They use financial statement:
– To ascertain the trend of profit of business.
– To plan profits for the future.
– To forecast the sales, purchases and different types of expenses on the basis of past data.
– To determine liquidity position of the business.
– To collect the different information for various decision making.
– To compare the efficiency of different employees, different departments, different policies and procedures.
In order to know the fact and actual position of short term liquidity position, the creditors analyze the financial statement.
They are founder investors of the company. They are equity shareholders. They want higher dividend on their investment. Dividend is totally depending on the profit. The more profit more dividends and vice versa.
Preparation of cash flow statement
There are two methods to prepare cash flow statement. They are:
1) Direct method
2) Indirect method
Both methods have three activities:
I) Operating activities
II) Investing activities
III) Financing activities
Only operating activities are difference between direct method and indirect method.
Investing activities and financing activities are same in both methods.
Those transactions which help us to determine the net income are known as operating activities.
It is based on current assets, current liabilities and income statement.
All cash flows other than investing activities and financing activities are operating activities. Profit and loss account or income statement is prepare on accrual basis. These accruals are outstanding, prepaid, depreciation and amortization etc.
These expenses should be adjusted :
– Cash received from customers.
– Cash paid to suppliers.
– Cash paid to operating expenses.
– Interest and insurance.
– Tax paid to the government.
– Dividend or interest received on investment.
– Short term loan borrow or repaid.
It is based on the non-Current assets or fixed assets. Purchase and sales of non-Current assets are calculated in investing activities.
Any increase in assets mean purchase of assets, it is outflow for the company.
Any decrease in assets mean sales or depreciation of assets. It is inflow of company.
If there is depreciation, loss, profit, purchase and sales of fixed assets in income statement or profit and loss account, working notes should be prepared.
It is based on non-Current liabilities or long term liabilities.
Issue of equity shares, preference shares and debentures; redemption of preference share and debentures; repayment of secured loan and unsecured loan; dividend paid etc are the part of investing activities.
Increase in shares and debentures mean issue of shares and debentures. It is cash inflow.
Decrease in preference share and debentures mean redemption of preference shares and debentures. It is a cash outflow.