Cash Flow Statement, Meaning, used, Importance

In financial reporting, three essential documents are pillars of transparency and accountability for every organisation: the Balance Sheet, Income Statement, and Cash Flow Statement. Among these, the Cash Flow Statement is a vital tool mandated for all registered companies under the revised Accounting Standard – III (AS – III).

What Is a Cash Flow Statement (CFS)?

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How the Cash Flow Statement Is Used?

1. Assessing Cash Position: It provides a clear picture of the cash inflows and outflows during a specific period, helping stakeholders understand how much cash the company generates from its operating activities, investments, and financing.
2. Monitoring Cash Trends: By comparing cash flow statements over different periods, stakeholders can identify trends in cash management. This helps forecast future cash flows and ensure sufficient liquidity to meet financial obligations.
3. Evaluating Operating Performance: The statement distinguishes between cash generated from operating activities and non-operating activities (such as investing and financing). This helps evaluate the business's core operational efficiency.
4. Planning and Budgeting: Businesses use cash flow statements for short-term and long-term financial planning. It assists in setting realistic budgets and making informed decisions about capital expenditures, dividend payments, and debt repayment.
5. Investment Analysis: Investors use the cash flow statement to assess a company's financial stability and sustainability. It provides insights into how efficiently a company manages its cash resources and its ability to generate future profits.
6. Creditworthiness: Lenders and creditors analyse the cash flow statement to evaluate a company's ability to repay debts. Positive cash flow from operating activities indicates strong financial health and enhances the company's creditworthiness.

Cash From Operating Activities

How to Prepare a Cash Flow Statement

1. Gather Financial Statements Before you begin, collect the necessary financial statements:

• Income Statement: Provides information on revenues, expenses, and net income.
• Balance Sheet: Shows the company’s assets, liabilities, and equity at the beginning and end of the period.

2. Determine the Reporting Period: I dentify the period for preparing the cash flow statement. This could be monthly, quarterly, or annually.
3. Choose the Method: Decide whether you will prepare the CFS using direct or indirect methods.

• Direct Method: List all cash receipts and payments during the reporting period.
• Indirect Method: Starts with net income and adjusts for changes in non-cash transactions.

4. Prepare the Statement

• Direct Method:
  1. List Cash Receipts: Include cash collected from customers.
  2. List Cash Payments: Include cash paid to suppliers, and employees, interest paid, and income taxes paid.
  3. Calculate Net Cash Flow from Operating Activities: Subtract total cash payments from total cash receipts.

• Indirect Method:
  1. Start with Net Income: Obtain this from the income statement.
  2. Adjust for Non-Cash Items: Add back depreciation and amortisation.
  3. Adjust for Changes in Working Capital: Account for changes in accounts receivable, inventory, accounts payable, and other working capital accounts.
  4. Calculate Net Cash Flow from Operating Activities: Combine the adjusted net income with changes in working capital.

Importance of a Cash Flow Statement

• A cash flow statement helps maintain an optimum cash balance by allowing a company to identify and manage cash shortages or surpluses.
• It provides detailed information about a company's spending, including transactions documented in cash that may not appear in other financial statements.
• It is an invaluable tool for short-term planning, helping a business meet upcoming payment obligations and anticipate cash requirements.
• It details an organisation's expenditures, covering everything from extending credit to customers to purchasing capital equipment and inventory.

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