CASH FLOW STATEMENT

SUBJECT: ACCOUNTING FOR MANAGEMENTCLASS: MBA I YEAR, I SEMESTER

Prepared by:Mrs. Bharathi Gorthi,

Asst. Professor,MVSR Engineering College, Hyderabad

Meaning of Cash Flow Statement• A cash flow statement is a statement of changes in the financial position of

a firm on cash basis.• It reveals the net effects of all business transactions of a firm during a period on

cash and explains the reasons of changes in cash position between two balance sheet dates.

• It shows the various sources (i.e., inflows) and applications (i.e., outflows) of cash during a particular period and their net impact on the cash balance.

• According to Khan and Jain:• “Cash Flow statements are statements of changes in financial position

prepared on the basis of funds defined as cash or cash equivalents.”• The Institute of Cost and Works Accountants of India defines Cash Flow statement

as “a statement setting out the flow of cash under distinct heads of sources of funds and their utilisation to determine the requirements of cash during the given period and to prepare for its adequate provision.”

• Thus, a cash flow statement is a statement which provides a detailed explanation for the changes in a firm’s cash balance during a particular period by indicating the firm’s sources and uses of cash and, ultimately, net impact on cash balance during that period.

Features of Cash Flow Statement

• The features or characteristics of Cash Flow Statement may be summarised in the following way:

1. It is a periodical statement as it covers a particular period of time, say, monthor year.

2. It shows movement of cash in between two balance sheet dates.

3. It establishes the relationship between net profit and changes in cash position of the firm.

4. It does not involve matching of cost against revenue.

5. It shows the sources and application of funds during a particular period of time.

6. It records the changes in fixed assets as well as current assets.

7. A projected cash flow statement is referred to as cash budget.

8. It is an indicator of cash earning capacity of the firm.

9. It reflects clearly how financial position of a firm changes over a period of time due to its operating activities, investing activities and financing activities.

Objectives of Cash Flow Statement1.It shows the cash earning capacity of the firm.2.It indicates different sources from which cash been collected

and various purposes for which cash has been utilised during the year.

3.It classifies cash flows during the period from operating, investing and financing activities.

4.It gives answers to various perplexing questions often encountered by management, such as why the firm is unable to pay dividend instead of making enough profit? Why is there huge idle cash balance in spite of loss suffered? Where have the proceeds of sale of fixed assets gone? etc.

5.It helps the management in cash planning and control so that there are no shortage or surplus of cash at any point of time.

6.It evaluates the ability of the firm to meet obligations such as loan repayment, dividends, taxes etc.

7.A prospective investor consults the cash flow statement to ensure that his investment gets regular returns in future.

8.It discloses the reasons for differences among net income, cash receipts and cash payments.

9.It helps the management in taking capital budgeting decisions more scientifically. 10. It ensures optimum use of funds for the maximum benefit of the enterprise.

Utility or Importance of Cash Flow Statement

• Cash Flow Statement is useful for short-term planning and control of cash. A business entity needs sufficient amount of cash to meet its various obligations in the near future such as payment for purchase of fixed assets, payment of debts, operating expenses of the business etc.

• It helps the financial manager to make a cash flow projection for the immediate future taking the data relating to cash inflows and cash outflows from past records. As such, it becomes easy for him to know the cash position which may either result in a surplus or a deficit one. Thus, cash flow statement is another important tool of financial analysis for the management.

Usefulness of CFS• The statement of cash flows is useful because it

provides answers to the following important questions:

• Where did cash come from?• What was cash used for?• What was the change in the cash balance?

Purpose of a statement of cash flows

•To provide information about the cash inflows and outflows of an entity during a period.

•To summarize the operating, investing, and financing activities of the business.

•The cash flow statement helps users to assess a company’s liquidity, financial flexibility, operating capabilities, and risk.

Advantages of CFS

1. Evaluation of Current cash Position for smooth operation of business:

2. Planning , co-ordinate and Control financial operations

From where cash will be derived, how much can be generated internally and externally.

3. Performance Evaluation:

A comparison of actual cash flow statement with the projected cash flow statement will disclose the failure or success of the management in managing cash resources. Deviations will indicate the need for corrective actions.

4. Framing Long-term Planning:

The projected cash flow statement helps financial manager in exploring the possibility of repayment of long-term debts which depends upon the availability of cash.

5. Capital Budgeting Decision:

A projected cash flow statement also helps the management in taking capital budgeting decisions.

6. Liquidity Position:

Able to understand how well the firm is meeting the financial obligations. At the same time the ability of the firm in cash earning can be known from cash flow statement. As a matter of fact, a firm’s profitability is ultimately dependent upon its cash earning capacity.

7. Answers to Different Questions:

Cash flow statement is able to explain some questions often encountered by the financial manager such as, why is the firm not able to pay dividend in spite of making huge profit? Why there is huge cash balance in spite of loss etc

1. Since cash flow statement does not consider non-cash items, it cannot reveal the actual net income of the business.

2. Cash flow statement cannot replace fund flow statement or income statement. Each of them has a separate function to perform which cannot be done by the cash flow statement.

3. The cash balance as disclosed by the projected cash flow statement may not represent the real liquid position of the business since it can be easily influenced by the managerial decisions, by making certain payments in advance or by post ponding payments.

4. It cannot be used for the purpose of comparison over a period of time. A company is not better off in the current year than the previous year because its cash flow has increased.

5. It is not helpful in measuring the economic efficiency in certain cases e.g., public utility service where generally heavy capital expenditure is involved.

Limitations

• A cash flow statement is the financial statement that measures the cash generated or used by a company in a given period.

• A cash flow statement typically breaks out a company's cash sources and uses for the period into three categories:

• cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities.

• It is important to note that cash flow is not the same as net income, which includes transactions that did not involve actual transfers of money (depreciation is common example of a noncash expense that is included in net income calculations but not in cash flow calculations).

• Cash flow from operating activities are generally calculated according to the following formula:

• Cash Flows from Operations = Net income + Noncash Expenses + Changes in Working Capital

• Because working capital is a component of cash flow from operations, investors should be aware that companies can influence cash flow by lengthening the time they take to pay the bills (thus preserving their cash), shortening the time it takes to collect what’s owed to them (thus accelerating the receipt of cash), and putting offbuying inventory (again thus preserving cash).

• Cash flow from investing activities primarily reflect the company's purchases or sales of capitalassets (that is, assets with a useful life of more thanone year that appear on the balance sheet). It isimportant to note that companies have some leeway about what items are or are not considered capital expenditures, and the investor should be aware of this when comparing the cash flow of different companies.

• Cash flow from financing activities typically reflect the company's purchase or sale of stock and any proceeds from or payments on debt financing. The measure varies with the different capital structures, dividend policies,or debt terms companies may have.

How it helps to external users for assessment about Company

Specifically, the information in a statement of cash flows, if used with information in the other financial statements, helps external users to assess:

1. A company’s ability to generate positive future net cashflows,

2. A company’s ability to meet its obligations and paydividends,

3. A company’s need for external financing,4. The reasons for differences between a company’s net

income and associated cash receipts and payments, and5. Both the cash and noncash aspects of a company’s

financing and investing transactions.

What can we learn from SCF that is not already available

in the other financial statements?

• It provides answers to important questions like: Where did cash come from?

What was cash used for?What was the change in the cash balance?

• Couldn’t we just look the balance sheet?• The change in cash could be determined, but the

statement of cash flows provides detailedinformation about a company’s cash receipts andcash payments during the period.

• Many things you want to know about a company is summarized in this one statement

• Operating, financing and investing cash flows

• Net income does not always tell the whole story about operating performance.

• A statement of cash flows is an excellent forecasting tool.

Cash and cash equivalents• It is a short-term, highly liquid investment.• It must be readily convertible to cash and it must be so

near to maturity that there is insignificant risks of changes in value due to changes in interest rate.

Operating Activities(Usually associated with working capital accounts like Accounts

receivable, inventory, salaries payable, etc.)Inflows:• From sale of goods and services• From receiving dividends investments• From receiving interest from investments or loans• From sale of trading securities• From reduced income taxes due to “excess tax deduction” related to stock

options• Outflows:• To suppliers for inventory and other materials• To employees for services• To other entities for services (insurance, etc.)• To government for taxes• To lenders for interest• To purchase trading securities

Investing Activities(Usually associated with

long-term assets)

Inflows:• From sale of property, plant and equipment• From sale of debt or equity investments of other

entities*• From collections of principal on loans to other entitiesOutflows:• To purchase property, plant and equipment• To purchase debt or equity securities of other entities• To make loans to other entities

Financing Activities(Usually associated with long-term liability and equity items)

Inflows:• From issuance of debt (bonds and notes)• From issuance of equity securities• Common stock Preferred

stock

Outflows:• To stockholders as

dividends• To repay or retire long-term debt, including capital leases

for lessee (interest on leases is classified as operating)

Thank you