by Cash Flow Statement is a financial report that provides a detailed analysis of a company’s cash inflows and outflows over a specific period. It categorizes cash activities into three main sections: Operating Activities (cash generated from day-to-day business operations), Investing Activities (cash used for or generated from investments in assets), and Financing Activities (cash exchanged with lenders and shareholders). This statement is crucial for assessing the liquidity, flexibility, and overall financial health of an entity, showing how well it manages its cash to fund operations, invest in growth, and return value to shareholders.
Merits of Cash Flow Statement:
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Liquidity and Solvency Assessment:
It provides a clear picture of the company’s ability to generate cash and meet its short-term obligations, showcasing its liquidity. Additionally, it helps assess the long-term solvency by showing how cash is being used for paying off debt.
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Cash Management:
By tracking the inflows and outflows of cash, companies can better manage their cash balances, ensuring they have enough cash on hand to cover expenses, take advantage of investment opportunities, and avoid excessive borrowing.
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Understanding Cash Impacts:
Unlike the income statement, which is prepared on an accrual basis, the cash flow statement shows the actual cash movements, helping stakeholders understand how changes in the balance sheet and income statement affect cash and cash equivalents.
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Investment Analysis:
Investors use the cash flow statement to assess the company’s financial health, the quality of its earnings, and its ability to generate positive cash flow, which is indicative of a company’s potential for long-term success.
- Comparability:
The cash flow statement enhances comparability between different companies by eliminating the effects of different accounting methods, providing a clearer view of a company’s performance and financial status.
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Performance Evaluation:
It helps in evaluating management’s effectiveness in generating cash from operations, making prudent investment decisions, and financing activities efficiently, which are critical aspects of company performance.
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Forecasting Future Cash Flows:
Historical cash flow data can be used to project future cash flows, aiding in budgeting and financial planning. This can help a company ensure it has sufficient liquidity to meet future needs and strategic goals.
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Identifying Trends:
Analysis over multiple periods can reveal trends in cash generation and usage, offering insights into the business cycle, seasonal impacts on cash flow, and the long-term financial strategy of the company.
Demerits of Cash Flow Statement:
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Non-cash Activities Exclusion:
The Cash Flow Statement does not include non-cash transactions, such as depreciation or amortization, which can be significant for understanding a company’s operating efficiency and the real cost of using its assets.
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Historical Nature:
It is primarily historical and backward-looking, detailing cash flows that have already occurred. This can limit its usefulness for predicting future cash flows or operational performance.
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Lack of Detail on Profitability:
While it shows how cash is generated and used, the Cash Flow Statement does not directly indicate the company’s profitability. Other financial statements, like the Income Statement, are necessary to get a complete picture of financial health.
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Requires Financial Literacy:
Understanding and interpreting the Cash Flow Statement requires a certain level of financial literacy. Stakeholders without this knowledge may find it difficult to gauge what the cash flows signify about the company’s performance and prospects.
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Not a Standalone Document:
To get a full understanding of a company’s financial status, the Cash Flow Statement must be viewed in conjunction with other financial statements like the Balance Sheet and Income Statement. By itself, it does not provide a comprehensive financial overview.
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Susceptible to Manipulation:
Companies can time receipts and payments to show improved cash flow in a particular period, which might not accurately reflect the ongoing financial condition. This practice, known as “window dressing,” can mislead stakeholders.
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Complexity in Preparation:
Preparing a Cash Flow Statement can be complex and time-consuming, particularly for large companies with numerous sources of cash inflows and outflows. This complexity can lead to errors or oversights.
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Limited Use for Non-Cash Intensive Businesses:
For businesses where cash transactions are not a primary activity, such as companies heavily reliant on credit transactions, the Cash Flow Statement may not provide significant insights into their operational efficiency or financial health.
Statement of Cash Flow Indirect method:
Statement of Cash Flows is a financial report that summarizes the cash inflows and outflows during a specific period. It is divided into three sections: operating activities, investing activities, and financing activities. The indirect method starts with the net income from the income statement and adjusts it for non-cash items and changes in working capital to calculate cash from operating activities.
1. Cash Flows from Operating Activities
This section begins with the net profit or loss before tax and adjusts for:
- Non-cash expenses such as depreciation, amortization, and provisions.
- Non-operating gains or losses like gains on the sale of assets.
- Changes in working capital, such as increases or decreases in current assets and liabilities.
Formula:
Operating Cash Flow = Net Profit/Loss + Non-Cash Expenses – Non-Operating Gains + Changes in Working Capital
Adjustments Include:
- Additions:
- Depreciation and amortization
- Losses on sale of fixed assets
- Increase in current liabilities
- Decrease in current assets
- Subtractions:
- Gains on sale of fixed assets
- Increase in current assets
- Decrease in current liabilities
2. Cash Flows from Investing Activities
This section records cash inflows and outflows from investment-related activities such as:
- Purchase or sale of property, plant, and equipment (PPE).
- Purchase or sale of investments.
- Interest and dividends received.
Example Transactions:
- Cash inflows: Proceeds from selling an asset or investment.
- Cash outflows: Purchase of equipment or investment securities.
3. Cash Flows from Financing Activities
This section tracks the cash impact of activities related to financing the business, such as:
- Raising or repaying loans.
- Issuing or repurchasing shares.
- Paying dividends.
Example Transactions:
- Cash inflows: Borrowings, issuance of shares.
- Cash outflows: Loan repayments, dividend payments, or buyback of shares.
4. Net Cash Flow
The net result of cash flows from operating, investing, and financing activities is calculated to show the change in cash and cash equivalents during the period.
Formula: Net Cash Flow = Operating Cash Flow + Investing Cash Flow + Financing Cash Flow
Format of Statement of Cash Flow (Indirect Method)
| Particulars | Amount |
|---|---|
| Cash Flows from Operating Activities | |
| Net Profit / (Loss) before Tax | XXX |
| Adjustments for Non-Cash and Non-Operating Items: | |
| – Depreciation | +XXX |
| – Amortization | +XXX |
| – Loss on Sale of Asset | +XXX |
| – Interest Expense | +XXX |
| – Gain on Sale of Asset | -XXX |
| – Interest Income | -XXX |
| Operating Profit before Working Capital Changes | XXX |
| Changes in Working Capital: | |
| – Increase in Current Assets | -XXX |
| – Decrease in Current Assets | +XXX |
| – Increase in Current Liabilities | +XXX |
| – Decrease in Current Liabilities | -XXX |
| Cash Generated from Operations | XXX |
| Income Taxes Paid | -XXX |
| Net Cash from Operating Activities (A) | XXX |
| Cash Flows from Investing Activities | |
| – Purchase of Fixed Assets | -XXX |
| – Sale of Fixed Assets | +XXX |
| – Purchase of Investments | -XXX |
| – Sale of Investments | +XXX |
| – Interest Received | +XXX |
| – Dividend Received | +XXX |
| Net Cash from/(Used in) Investing Activities (B) | XXX |
| Cash Flows from Financing Activities | |
| – Proceeds from Issue of Share Capital | +XXX |
| – Proceeds from Borrowings | +XXX |
| – Repayment of Borrowings | -XXX |
| – Interest Paid | -XXX |
| – Dividend Paid | -XXX |
| Net Cash from/(Used in) Financing Activities (C) | XXX |
| Net Increase/(Decrease) in Cash and Cash Equivalents (A+B+C) | XXX |
| Add: Cash and Cash Equivalents at Beginning | XXX |
| Cash and Cash Equivalents at End | XXX |
Key Components Explained
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Cash Flows from Operating Activities
Adjusts net profit with non-cash items (like depreciation) and changes in working capital.
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Cash Flows from Investing Activities
Reflects cash used in or generated from investment transactions like purchasing or selling fixed assets and investments.
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Cash Flows from Financing Activities
Shows the cash flow resulting from funding activities such as borrowing, repaying loans, or issuing shares.
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Net Cash Flow
Summation of the cash flows from all activities to show the overall change in cash position.
Example
| Particulars | Amount (₹) |
|---|---|
| Cash Flows from Operating Activities | |
| Net Income | 50,000 |
| Add: Depreciation | 10,000 |
| Less: Gain on Sale of Equipment | (5,000) |
| Add: Increase in Accounts Payable | 8,000 |
| Less: Increase in Accounts Receivable | (12,000) |
| Net Cash from Operating Activities | 51,000 |
| Cash Flows from Investing Activities | |
| Sale of Equipment | 15,000 |
| Purchase of Equipment | (20,000) |
| Net Cash from Investing Activities | (5,000) |
| Cash Flows from Financing Activities | |
| Proceeds from Issuance of Shares | 25,000 |
| Repayment of Loan | (10,000) |
| Net Cash from Financing Activities | 15,000 |
| Net Increase in Cash and Cash Equivalents | 61,000 |
