Guide to Cash Flow Statement with FAQs
- Blog|Account & Audit|
- 7 Min Read
- By Taxmann
- |
- Last Updated on 18 August, 2024
A Cash Flow Statement is a financial document that provides a summary of the cash inflows and outflows for a business over a specific period of time, typically a month, quarter, or year. This statement is one of the three main financial statements used to assess a company's performance and financial health, alongside the balance sheet and the income statement. The Cash Flow Statement is essential for understanding how well a company generates cash to fund its operating expenses, pay its debts, and fund its investments without requiring external financing. This statement also provides critical insight into the liquidity and financial flexibility of a business.
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1. Introduction
The statement of cash flows shall report cash flows during the period classified under the following three categories —
- Cash flow from operating activities;
- Cash flow from investing activities; and
- Cash flow from financing activities.
Note: Sum of these three types of cash flows reflects the net change in cash and cash equivalent of the entity.
2. Cash and Cash Equivalents
- Cash shall consist of cash in hand and demand deposits; and
- Cash equivalent consist of short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.
3. Types of Cashflows
(a) Cash flow from operating activities
Cash flows from operating activities are primarily derived from the principal revenue producing activities of the entity. Therefore, they generally result from the transactions and other events that enter into the determination of profit or loss.
Examples of cash flows from operating activities are:
- cash receipts from the sale of goods and the rendering of services;
- cash receipts from royalties, fees, commissions and other revenue;
- cash payments to suppliers for goods and services;
- cash payments to and on behalf of employees;
- cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy benefits;
- cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and
- cash receipts and payments from contracts held for dealing or trading purposes.
Note: Cash received on account of sale of an item of plant is a cash flow from investing activities.
Again, cash flows arising from the purchase and sale of dealing or trading securities are classified as operating activities. Similarly, cash advances and loans made by financial institutions are usually classified as operating activities since they relate to the main revenue-producing activity of that entity.
(b) Cash flow from investing activities
The activities of acquisition and disposal of long-term assets and other investments not included in cash and cash equivalents are investing activities. However, only expenditures that result in a recognized asset in the balance sheet are eligible for classification as investing activities.
Examples of cash flows arising from investing activities are:
- cash payments to acquire property, plant and equipment, intangibles and other long-term assets. These payments include those relating to capitalised development costs and self-constructed property, plant and equipment;
- cash receipts from sales of property, plant and equipment, intangibles and other long-term assets;
- cash payments to acquire equity or debt instruments of other entities and interests in joint ventures (other than payments for those instruments considered to be cash equivalents or those held for dealing or trading purposes);
- cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures (other than receipts for those instruments considered to be cash equivalents and those held for dealing or trading purposes);
- cash advances and loans made to other parties (other than advances and loans made by a financial enterprise);
- cash receipts from the repayment of advances and loans made to other parties (other than advances and loans of a financial enterprise);
- cash payments for futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and
- cash receipts from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities.
(c) Cash from financing activities
These are activities that result into change in size and composition of owner’s capital and borrowing of the organisation. Accordingly, it includes receipts from issue of shares, bonds and other instruments, borrowing and repayment of loans.
Examples of cash flows arising from financing activities are:
- cash proceeds from issuing shares or other similar instruments;
- cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short-term or long-term borrowings;
- cash repayments of amounts borrowed.
4. Frequently Asked Questions
FAQ 1. What is the meaning of the expression ‘cash equivalent’?
Cash equivalent means bank balance and other risk-free short-term investments and advances which are readily encashable. Cash equivalents means 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.
FAQ 2. State the classification of cash flow activities as per AS-3?
Cash Flow Statement explains cash movements under three different heads, namely:
- Cash flow from operating activities;
- Cash flow from investing activities;
- Cash flow from financing activities.
FAQ 3. Write a short note on objectives of preparing Cash Flow Statement?
Objectives of preparing Cash Flow Statement:
- To provide information about firm’s liquidity, flexibility and ability to generate future cash flow.
- To provide information about firm’s ability to meet future obligations.
- To enhance comparability among firms.
- To assess reliability of net profit and quality of earnings.
- To enable the users to assess how assets and liabilities have increased or decreased.
- To project future cash flow streams.
- To provide information on different types of cash flow.
FAQ 4. What are the reasons for the preparation of Cash Flows?
- Cash Flow statement is considered to be a summarized statement showing sources of Cash Inflows and application of cash outflows of an enterprise during a particular period of time.
- It is prepared on the basis of the published data as disclosed by the Financial Statement of two different financial periods.
- It is an essential tool for managerial decision-making.
- Cash Flow Statement reports the management net Cash Flow (i.e. cash inflow less cash outflow or vice versa) from each activity of the enterprise as well as of the overall business of the enterprise.
- The management of the enterprise gets a picture of movement of cash resources from the Cash Flow Statement and can assess the stronger and weaker area of movement of cash for different activities of the business for drawing up the future planning.
FAQ 5. What is the difference between Cash Flow Statement & Fund Flow Statement?
Following are the main points of difference between cash flow statement & fund flow statement:
Points | Cash Flow Statement | Funds Flow Statement |
Meaning | A cash flow statement is a statement showing change in cash position from one period to another. | Fund flow statement is statement of sources & application of funds and statement of changes in working capital. |
Concerned with | Cash flow statement is concerned with cash only, which is only a part of the working capital. | Funds flow statement is based on a wider concept of fund i.e. working capital. |
Adjustments for
prepaid & outstanding |
In the case of cash flow statements adjustments requires for prepaid and outstanding items. | No such adjustments are needed in the case of funds flow statement. |
Opening or closing balance | Cash flow statement is covers opening and closing balance of cash and cash equivalents. | Funds flow statement does not cover opening and closing balance of cash and cash equivalents. Such items are covered in statement called ‘changes in working capital’. |
Use | Cash flow statement is generally used as a tool of short-term financial analysis and cash planning purpose. | Funds flow statement is useful in planning sources and application of various funds. |
FAQ 6. What are the benefits of a cash flow statement? Which parties benefit from preparing a cash flow statement?
A cash flow statement is a statement showing change in cash position from one period to another. It presents a summary of cash flows from operating, investing and financing activities.
Example:
Cash balance as on 31.12.2023 – ` 20,000 Cash balance as on 31.12.2024 – ` 30,000
Thus, there has been an inflow of cash of ` 10,000 in the year 2024.
A projected cash flow statement: It presents a summary of projections of all the future cash flows from operating, investing and financing activities.
Benefits of cash flow statement: A cash flow statement is very useful in short range planning. It enables the management to plan the acquisition and utilization cash for a sound financial position. The importance and uses of cash flow analysis can be summarized in the following respects:
- It explains the reasons for inflows and outflows of cash.
- It is important tool for planning cash requirements and for controlling the cash position.
- It facilitates the management to plan and co-ordinate the financial operations properly.
- It helps for making plans for the future.
- It helps in ascertaining how much cash will be available to meet obligations to trade creditors, to pay bank loans and to pay dividend to the shareholders.
- It enables the management to invest it to some profitable investments.
- It helps to improve liquidity.
- Long-term lenders of funds can use the statement as a means of estimating the firm’s ability to serve its debts.
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