Cash Flow Statement
Cash flow statement or the Statement of Cash Flows is one of the main Finacial Statements.This statement shows the cash generated and used up during a given period of time.
It is a simple and easy to understand statement which shows how cash was obtained and how it was spent during a particular period.
Simply stated Cash Flow Statement is just a summary of your Cash Book classified under three headings i.e.
1. Cash from operating activities
2. Cash from Investing activities
3. Cash from financing activities
What does it tell us?
Cash Flow Statement helps its users to find answers to the following questions….
1. Where did the cash come from during the period?
2. What was the cash used for during the period?
3. What was the change in the cash balance during the period?
Why do I need cash flow statement when my final accounts depict all the required information about my concern?
Frequently this question can arise in your mind that what is the need for making Cash flow statement when your Financial Statements can depict all the information about your business. Any body who is interested in dealing with you can see your Income Statement and Balance sheet and know about the profits and financial position of your busness, then why you are required to make this additional statement.
As we know the Income statement (Trading and Profit and Loss Account) is prepared on accrual basis of accounting so the revenue that it shows as earned during a given period may not have been collected yet. But most of the concerns dealing with us are more interested in our liquidity position just to be sure of the sources from where we would be getting cash and the uses to which we would be putting it in a specified period of time.
For explaining you the significance of this statement we give you an example. Let us assume that your company desires to raise a loan from a financial institution. For the purpose of convincing the management of the financial institution or bank to obtain this loan your company normally highlights the profits earned over years as its strength. But your profits do not guarantee the liquidity of your business i.e. how readily you would be able to repay the loan as well as interest. And moreover the manager of the bank may not be sure how you arrived at that profit. As we daily hear about so many business scams, he would be interseted to know if you have actually earned the profits or not. Cash flow statement will help him in finding how much profits you have actully realised.
Moreover a company that shows high level of profits may not be liquid in cash. And your bankers, your suppliers ,investors, as they have no control over the management of your company,will be interested to know about your cash position to determine if they would get their money back in time. Here the Cash Flow Statemenmt comes to help them as this statement very clearly shows the sources as well as the uses of cash during the period specified in the heading of this statement.
Cash Flow Statement: Methods
For preparing cash flow statement we have two methods.
1. Direct Method
2. Indirect method
Actually these two methods differ on the part in which we compute Cash from Operating Activities. While direct method logically summarises movement of cash flows under broad operating heads, the indirect method works backwards taking Net profits as the starting point and works backwards removing all the non cash and non operating incomes and expenses to get Cash From Operating Activities. Once we have calculated Cash from Operating Activities, the procedure followed for getting cash received or used under other two subheadings (Investing and Financing activities) is same under both the methods.