A cash flow statement is a report that gives information about the changes in cash or cash equivalents of a business by classifying cash flows into operating, investing and financing activities. It is also a key report which is prepared for each accounting period for which the financial statement prepared by a business entity.
Monitoring the cash situation of any business is the key to its profitability. The income statement would reflect the profits but does not indicate the cash components. The cash flow statement covers the flow of cash over time, unlike the balance sheet that provides a picture on a particular date.
Objectives of Cash flow statement
- It shows inflow and outflow of cash and cash equivalents from various activities of a company during a specific period of time.
- It provides information which is useful in assessing the ability of any company to generate cash or cash equivalents and needs of the company to utilize those cash flows.
- It helps to take economic decisions by evaluating the ability of a company to generate cash and cash equivalents.
Components of cash and cash equivalents
- Cash in hand
- Cash in Bank
- The short term liquid investment
- Bank’s overdrafts which are part of treasury management
Classification of cash flow activities
- Cash from operating activities
These are the primary and main activities of a company during an accounting period. For example for a garment manufacturing company, operating activities include procurement of raw material, sale of garments, incurring manufacturing expenses, etc. These are the primary revenue generating activities of a company. The profit before tax as represented in the income statement could be used as a starting point to calculate cash flow from operating activities.
Cash inflows in operations are
- Cash receipts from sales of goods and rendering services.
- Cash receipts from commissions, fees, royalties, and other revenues
Cash outflows from operations are
- Cash payments to suppliers for goods & services
- Cash payments to income tax unless they can be specifically identified with financing and investing activities.
The amount of cash from operations indicates the internal solvency level of the company. It indicates the extent to which the company’s operation is able to generate sufficient cash flows to sustain its operating potential.
Following adjustment are required to be made to the profit before tax to arrive at the cash flow from operation.
- Elimination of non-cash expenses like depreciation, amortization, impairment losses, bad debt written off, etc.
- Removal of expenses which are classified elsewhere in the cash flow statement like interest expense which should be classified under financing activities.
- Removal of incomes like dividend and interest incomes which comes under investment activities.
- Removal of non-cash income like gain on revaluation of investments.
- Cash flows from investment activities
These include the cash movement owing to the sale & purchase of assets like machinery, furniture, land, and building, etc.
Cash inflows from investing activities are
- Cash receipts from disposal of fixed assets including intangibles.
- Cash receipts from repayment of advances and loans made to third parties (except in case of financial Companies).
- Dividends received from investment in other Companies.
- Cash receipts from disposal of shares, warrants and debt instruments of other companies except those held for trading purposes.
Cash outflows from investing activities are
- Payments to acquire fixed assets including intangibles and capitalized R&D.
- Cash advance and loans made to third parties.
- Payments to acquire shares warrant and debt instruments of other companies, other than those held for trading purposes.
Cash flows from financing activities
It includes the financing activities related to long term and capital of a company. Such activities affect the size and composition of the owner’s capital and borrowings of the company. Examples are cash proceeds from the issue of equity shares, debentures, raising long term loans repayment of Bank’s loan, etc.
Cash inflows from financing activities are
- Cash proceeds from issuing shares.
- Cash proceeds from issuing debentures and short term / long term borrowings.
Cash outflows from financing activities are
- Repayment of the borrowed amount.
- Interest paid debentures and long term loans and advances.
- Dividend paid on equity and preferential capital.
It is a fact that financial reports like balance sheet and income statements are the reflections of the overview of the financial position of a company but it might conceal some crucial information’s. However, the cash flow statement is a transparent and fair document which shows the financial reality of the company.