The balance sheet is a preview of entity’s financial resources and commitments at a specific place of time and the statement of profit and loss mirrors the financial performance for the period. These two parts of financial statements are based on accrual basis of accounting. However, the cash flow statement incorporates just inflows and outflows of cash and cash equivalents. It excludes transactions that doesn’t influence cash receipts and payments.
The data on cash flows is helpful in surveying sources of creating and deploying cash and cash equivalents during a period. Also, a cash flow statement can be utilized for correlation with earlier period of the same entity just as comparison with different entities for the same period.
Ind AS 7, Statement of Cash Flows, endorses standards and direction on preparation and presentation of cash flows of an entity from operating activities, investing activities and financing activities for a period.
What is a Cash Flow?
Cash flow statement is a statement, which gives the insights concerning how the cash is generated by an entity during a particular period and how it is applied. At the same time, it mulls over the opening balances of cash and cash equivalents, adds the cash generated, deducts the cash payments and reconciles it with closing balances of cash and cash equivalents. The cash flows are characterized into following three fundamental categories:
- Cash flows from Operating Activities
- Cash flows from Investing Activities
- Cash flows from Financing Activities
What are the objectives of a Cash Flow Statement?
To provide information about historical changes in cash and cash equivalents
Cash flow statement targets giving the data about how the cash has been generated during a period and for what purposes has it been used.
Consequently, data will be provided for the current period and the period immediately prior to it.
To assess the ability to generate cash and cash equivalents
Cash flow statement proposes to give the stakeholders insights about the efficiency of the organization in generating cash and cash equivalents.
A few organizations may look profitable according to profit and loss account yet whether they have sufficient cash for payment of their obligations must be evaluated by utilizing cash flow statement.
To understand the timing and certainty of their generation
What are the benefits of a Cash Flow Statement?
Gives information about liquidity and solvency enabling assessment of changes in net assets and financial structure
Cash flow statement reconciles the opening balances of cash and cash equivalents with the closing balances of cash and cash equivalents, giving the explanations behind the progressions occurred during the year.
Hence, it gives a clear image of cash inflows and outflows that have occurred during the period.
Assesses the capacity to manage cash
The stakeholders find out about what is the source of generation of cash and how it is utilized for. The data gives a reasonable idea regarding the efficiency and capacity of the organization to generate cash.
For instance, assume there is negative cash flow from operations. It signifies that organization can’t generate cash from its principal business activity, which is definitely not a good situation.
Cash flow statements can likewise suggest if an organization could generate adequate cash or not.
For instance, an organization needs to extend its production capacity. The cash flow statement can show whether the organization could generate the necessary cash from their activities, or whether the organization has generated the funds from share capital or whether the organization has taken an advance or loan.
Evaluate the present value of future cash flows
The previous patterns of cash flows will assist the organization to foresee future cash flows.
Such data is helpful while assessing the projects on capital budgeting or valuation of shares.
Hence, it frames the base for future activities and can be discounted utilizing discounting methods.
Compares the efficiency of different organizations
Profits of different entities may have various assumptions, policies and definitions.
Nonetheless, cash flows will be calculated by utilizing the same method.
Consequently, this eliminates all contrasting assumptions across the organizations and an organization can reach to a comparable base of cash and cash equivalents.
In a nutshell...
Each organization, regardless of its size, whether it’s a manufacturing concern or a trading concern or a service provider, needs cash for maintaining its business. The cash is likewise required for future speculations. Cash would be required for mostly everything such as payment of creditors, repayment of loans etc. Accordingly, every organization needs to generate cash and use cash persistently.
Additionally, Banks and Financial organizations are not an exemption. Regardless of whether they manage financial products, accept deposits and issue loans every day, they need to generate cash profit. They need to make investments regarding new branches, set ups and so on.
Hence, cash flow statement is equally significant for every organization irrespective of its size or industry.
