Cash Flow Statement: Process & Examples [Complete Guide]

A cash flow statement means statements relating to information regarding the inflow and outflow of cash. Nowadays, in preparing financial statements, the cash flow statement is considered an important element. Generally, a cash flow statement is prepared for a particular period or a financial year.

The primary objective of the cash flow statement is to help management in making a decision and making a plan by providing current information on cash inflow and outflow of any accounting period.

During 1960, the cash flow statement was considered with due importance in the United States of America.

In this context, International Accounting Standard Committee introduced the International Accounting Standard-7 on cash flow statement considering its importance.

Later, in 1992 it was published in modified forms.

Cash flow statement means inflow and outflow of cash of a particular period which is divided into:

Cash flow from operating activities,
Cash flow from investing activities and
Cash flow from financing activities; and
Determines the amount separately for each head and presents discloses of the same.

Thereby companies present cash and cash-equivalent items that are shown on their balance sheet.

In section – J of International Accounting Standard – 7, it is stated, a complete financial statement contains an income statement, balance sheet, retained earnings statement, cash flow statement, and accounting principles and notes to the financial statement.

Therefore, the cash flow statement is considered an important element of the financial statement.

A cash flow statement means a statement relating to information regarding the inflow and outflow of cash. Nowadays, in preparing financial statements, the cash flow statement is considered as an important element.

The cash flow statement plays an important role in making decisions and planning by investors, creditors, and management.

Objectives of Cash flow statement

The main objective of preparing cash flow statements for a particular accounting period is to present information regarding the inflow and outflow of cash.

Besides,

It presents the investment and financial activities of a concern for a particular period. It also fulfills the following objectives;

Ensuring future positive cash flow of particular concern.
Ensuring the capacity of an organization to pay a dividend.
Identifying non-cash items ensures cash income and expenses of concern.
Comparing various items of the current year with those of last year.

Knowing cash and cash equivalent and outsourcing inflow of a concern for a particular period.

Moreover, the cash flow statement plays an important role in planning and controlling the future courses of action of a business concern.

It also helps shareholders and potential investors in taking short-term and long-term decisions.

Classification of Cash flow statement

Cash flow is divided into three parts.

Cash flow from operating activities.
Cash flow from investing activities.
Cash flow from financing activities.

Advantages of Cash flow statement

The cash flow statement is recognized as an indispensable part of the financial statements for its characteristics.

The use of the cash flow statement in the form of cash and cash equivalent as the current asset and its direct influence on fixed assets and other current assets do exist.

The three main elements of the financial statements, balance sheet, income statement, and cash flow statements, represent a financial position, trend, and business activities of a business concern, respectively.

The main advantages arising out of the cash flow statement are as follows;

It provides information relating to cash flow, net assets difference, and liquidity of a business concern.
It provides information relating to the size and kind of cash and cash equivalent.
It helps a company in getting an idea of future cash positions.
In preparing reports, it presents events and transactions from different angles by which management can take multipurpose decisions.
The cash flow statement prepared with historical information helps in determining the future cash flow of the company.
A primarily prepared cash flow statement can be compared to the cash flow statement prepared considering the present rise and fall of price.
A three-part cash flow statement presents the true financial picture of concern.

Cash and Cash Equivalent

According to section 6 of the International Accounting Standard – 7 cash means cash in hand and cash at the bank.

Cash in hand means cash in notes and coins, which are kept in the cash box.

Besides, prize bonds, negotiable instruments, postal orders, un-deposited checks, bank draft, bank pay orders are also considered as cash.

Bank deposit means cash deposited into the bank and payable on demand.

In section 6, it is further stated that cash and cash equivalent include short-term highly liquid assets easily convertible into cash and measurable regarding money. So, cash equivalents are;

Convertible into cash within three months.
Highly liquid and capable of paying debts.
Easily convertible into cash and risk-free.

Importance of cash flow statement

The cash flow statement is an important and necessary example of cash management. Since the cash flow statement is prepared by cash records, it is very important in the evaluation of the cash position of a business concern.

Sometimes a business concern faces problems in paying dividends and income tax due to the shortage of cash, although it earns sufficient profit.

Again sufficient cash may remain in the business through its profit is not sufficient.

The reasons for which these situations arise cannot be known directly from the income statement and balance sheet, but these can be known from the cash flow statement.

On consideration of the importance of cash flow statements nowadays, the cash flow statement is also prepared along with financial statements.

The importance and necessity of the cash flow statement are stated below;

Evaluation of cash position

Since the cash flow statement is prepared by cash records, it is very much useful in evaluating the cash position of a business concern.

The expected amount of cash helps the management in deciding on short-term investments.

Contrarily, if the cash shortage arises, the management can find out the possible sources of cash for meeting various expenditures.

Getting an idea of future cash position

By various information, a probable cash flow statement is prepared so that a clear idea regarding future cash position can be achieved by making a plan and adjustment regarding financial activities.

With the help of this statement, a business concern can find out sources of cash needed and the amount of cash to be spent on different heads.

Correction of decision

The comparison is made between the historical cash flow statement and a projected cash flow statement. If any deviation is marked, the management can take corrective measures.

Picture of liquidity position

Every business organization should possess the required liquidity. In light of it, the cash flow statement is prepared and compared with those of similar business organizations and concerned departments of the organization.

In such a case, whether the trend of liquidity is in progress or degrees can be known.

Framing long term-planning

In the case of investment and financing, both cash quantity and time are significant to the management. A projected cash flow statement helps the management in this respect.

The cash flow statement helps largely in respect of loan payment, preference share capital payment, replacement of fixed assets, and other long-term plans.

Searching for solutions to various problems

Answers to various questions can be known from the cash flow statement.

For example, how the net profit has been earned, where that profit has gone, why dividend could not be paid despite sufficient profit, how the tax will be paid, what types of fixed assets have been purchased in a particular financial year, whether any fixed assets have been sold if sold how that cash has been utilized etc.

More important than a fund flow statement

In the case of short-term investment since cash is more important than working capital, the cash flow statement is more important than a fund flow statement for short-term financial analysis.

Useful to interested outside parties

The cash flow statement is not less important to those who use the published financial statements of a company. Potential creditors always remain eager to know about the liquidity position of concern before making any transaction.

They also like to be aware of the profit earning capacity of the concern.

The cash flow statement helps in both cases. Bank and tax authorities also depend very much on the cash flow statement.

Limitations of the cash flow statement

Although the cash flow statement is an important element of cash management, it has got some limitations.

The limitations of the cash flow statement are discussed below:

The difference of opinion relating to the word – ‘Cash’: The word ‘cash’ is easily understandable by common people but difficult to explain or define. In the greater sense, stamps, cheques, postal orders, etc. should be included under cash title. But there prevail great differences of opinion in this matter. The accepted principle is not yet established in this regard.
A clear picture of cash position not available: The sources of inflow and out the flow of cash can be known from the cash flow statement. But a clear cash picture cannot be known from the cash flow statement as some cash equivalent items are excluded.
Fund flow statement more important: Since the working capital is considered as a larger concept of the fund, the fund flow statement is more important than the cash flow statement. Because the fund flow statement exhibits a clear picture of the fund.
Incapable of ascertaining the amount to be spent on fixed assets and long-term investment: The cash flow statement cannot ascertain the amount to be spent on fixed assets and long-term investments.

Fix Missing Figures in Cash Flow Statement

Generally, a cash flow statement is prepared for a particular period or a financial year.

The balance sheet and income statement are sources of information. The collected information from these two statements is grouped into three parts in the cash flow statement.

Net cash inflow and cash outflow for a particular period or a financial year can be known from the cash flow statement.

Closing cash balance is determined to add opening cash balance to net cash inflow.

How to Fix Missing Figures in Cash Flow Statement

The three parts – contain with which the cash flow statement is prepared are;

Cash flow from operating activities,
Cash flow from investing activities, and
Cash flow from financing activities.

The techniques of ascertaining missing figures of three parts of cash flow are discussed below;

Cash flow from operating activities

Cash flow from operating activities means inflow and outflow of cash through business activities. The inflow of cash mainly depends on sales, and the outflow of cash depends on the expenses of the business.

Cash collection: Cash receipts or cash collection are related to cash flow from operating activities. Since cash collection is not directly mentioned in the problem, it is ascertained through the adjustment of various accounts. In this case, cash collection is determined to add opening receivables with net sales of the year and to subtract closing receivables therefrom. Besides, other incomes, if any, are also added to it, for example, the sale of scraps, interest on investment, etc.
Cash payment: In this case, a total of various expenditures other than depreciation expense is added to the cost of goods sold to determine the total amount of cash payment.
Increase-decrease of current assets and current liabilities: In this case, the difference between current assets and current liabilities of the current year and last year is accounted for. Adjusting the above-mentioned three steps, cash inflow or cash outflow from operating activities is determined.

Cash flow from investing activities

The cash inflow of cash outflow for a particular period is determined from the inflow and outflow of fixed assets of a business concern. In this case, generally, cash outflow is marked.

Cash flow from financing activities

Financing is made for carrying out the overall activities of a business. The amount of inflow of cash from financing for a particular period or year is determined.

Cash inflow or cash outflow is determined to take into consideration the sale of new shares in the market, payment of dividends, taking a long-term loan, the redemption of bonds, etc.

The net result of cash inflow and cash outflow for a particular period of a business can be known from the above-mentioned three steps.

The closing balance of cash is determined to add the opening cash balance to net cash flow.

If the determined closing cash balance equals closing cash balance as shown on the balance sheets, it is assumed that the cash flow statement is correct.

3 Major Activities into which the Statement of Cash Flow is Classified. or
Describe the 3 Categories of Adjustments that Convert Net Income to CFO

There are three types of information used for the financial statement obtained from the SCF.

Now the three information systems are as follows:

Operating Activities: The operating activities relate to the income statement as well as balance sheet items, mostly working capital account receivable, inventories, prepayment, account payable, & accruals. SFAS95also specifies that it is not of an investing or financing nature, for example, the amount received to settle a lawsuit.
Financing Activities: Include obtaining resources from owners & providing them with a return on their investment.
Investing Activities: These activities include acquiring & selling or otherwise disposing of securities that are not cash equivalents, & productive assets that are expected to generate revenue over the long there. For example, Proceeds of borrowing shall be reported separately from repayment assets acquisitions separately from assets dispositions.

Discuss the advantages of the International Accounting Standards Approach to the cash flow statement?

There are so many advantages of the International Accounting Standards Approach to the cash flow statement. Now there are as follows:

Cash from investing activities: in the statement of cash flows, the sale of property, plant, & equipment represents an investing activity.
Net changes in cash can be leaned earns from net changes in all other Balance sheet account.
Cash flow is universally acknowledged to be the most liquid asset.
Cash flow is key to the reconstruction of many transactions, which is an important analytical process & skill.
The financial statement that a cash flow statement would be more useful than any “other funds flow Statement.
Cash flow statement to help prepare financial statements report both financial position & result of the operation.
It provides a useful framework for understanding the interaction between cash & all other balance sheet accounts.