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Cash Flow Statement: An Overview



Cash Flow Statement


What is Cash flow statement?

The cash flow statement is an important planning tool in the hands of management. A cash flow statement is useful for short-term planning. A simple definition of a cash flow statement is a statement which discloses the changes in cash position between the two periods.


For example, a balance sheet shows the balance of cash as on 31.12.2015 at $20,000, while the cash balance as per its latest balance sheet as on 31.12.2016 was $30,000. Thus, there has been an inflow of $10,000 during a year’s period.


Along with changes in the cash position, the cash flow statement also outlines the reasons for such inflows or outflows of cash which in turn helps to analyze the functioning of a business. In order to meet its various obligations in the near future, a business venture needs adequate cash. The past analysis of the diverse sources and applications of cash will enable the management to make reliable cash flow projections for the immediate future. It may then plan out for the investment of surplus or meeting the deficit if any.


The term cash comprises cash on hand, demand deposits with the banks and includes cash equivalents. Cash equivalents are short-term highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value. Their primary purpose is to meet the short-term cash commitments.  It is not for investment or other purposes.


Significance of preparing cash flow statement

  • It puts the light on the various sources and application of the cash for a company. Also, it discloses the amount of the cash flows in the different segments of the business, thereby helping to analyze the different segments of the business.


  • Cash flow information is useful in determining the potential of the enterprise to generate cash and cash equivalents. It further enables users to build up models to assess and compare the present value of the future cash flows of various enterprises. With the help of this cash flow models, we can easily compare the operating performance of various enterprises.


  • Cash flow statement helps to estimate the amount of cash that will be available at a particular point of time to meet obligations like payment to trade creditors, repayment of cash loans, dividends, etc. This estimate reflects the information about the liquidity and solvency information of an enterprise.


  • Past cash flow data is often used as a forecasting tool for the amount, timing and certainty of future cash flows.


  • It is also useful in examining the relationship between profitability and net cash flow.


  • A proper planning of the cash resources is possible with the help of cash flow statement. It will further enable the management to make available sufficient cash whenever needed and invest surplus cash if any in other profitable projects.


  • It helps in determining how efficiently the cash is being managed by the management of the business.


LIMITATIONS OF CASH FLOW ANALYSIS

Cash flow analysis is a useful tool for financial analysis. However, it has its own limitations.

  • Cash flow statement is not the substitute for the Income Statement. An Income Statement takes into consideration both cash as well as non-cash items and, therefore, net cash flow does not necessarily mean net income of the business.


  • The cash balance as per the cash flow statement may not always reflect the real liquidy position of the enterprises because it can be easily influenced by postponing purchases and other payments.


  • Cash flow statement cannot replace the Funds Flow Statement. Each of them has a separate function to perform.

Also Read: Breaking Down the Cash flow statement

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