A Complete Guide to Cash Flow Statement - Fund Flow, Liquidity and Limitations

The Cash Flow Statement

The balance sheet and statement of profit and loss not gives the information about the cash inflow and outflow. To neglect this problem institute makes a cash flow statement.

A cash flow statement is a statement that shows the flow of cash and cash equivalent during the period under report. Cash inflows and outflows of cash and cash equivalent.

Importance of Cash Flow Statement

1. Short-term planning- Cash flow statement provides information about the cash and cash equivalent for a specific period. It helps in planning investments and assessing the financial requirement of the enterprise.

2. Helps to determine liquidity and solvency- Solvency is the ability that shows the power of the company to meet their liability.

3. Efficient cash management- Cash flow statement tells about the surplus or deficit of cash. So that, an enterprise can decide about the short-term investment of the surplus and can arrange the short-term credit in case of deficit.

4. Comparative information- A comparison of the actual cash flows with the past cash flows which give a perfect differentiation.

5. Dividend decision- Cash flow statement helps in decision-making how much dividend should be paid because the dividend payable is deposited in a separate bank account.

Limitations of Cash Flow Statement

1. Non-cash transactions are not shown- The cash flow statement only shows cash inflow and outflow so this is also a limitation because we can see flows of non-monetary items.

2. Not a substitute of the statement of profit and loss- Income statement shows net profit and a net loss of the enterprise whereas cash flow statement shows only cash flows which do not represent net profit and net loss.

3. Historical in nature- It rearranges available information in the income statement and balance sheet. Thus, it is historical in nature.

4. Assessment of liquidity- liquidity of the enterprise cannot be determined because liquidity includes all current assets and current liability. So, a cash flow statement cannot determine the liquidity of the business.

5. Accuracy- Cash flow statement is prepared from financial statements. If the financial statements are not correct then the cash flow statement will also be incorrect.

Classification of The Cash Flow Statement

Cash flow statement is prepared on the basis of three activities-

Operating activity

Investing activity

Financing activity

Operating activity - Operating activity is the principal revenue from producing activity of the enterprise and other activities that are not investing and financing.

Examples of operating activity for a non-financial company:

Receipts from the sale of goods.

Receipts from royalties, fees, and commission, etc.

Receipts from trade receivable( debtors and bills receivable)

Receipts of premium paid and payment of the claim.

Examples of operating activity for a financial company:

Payment for purchase of securities.

Payment of interest on loans.

Dividend received.

Interest received on loans.

Investing activity - Investing activities are the acquisition and disposal of the long-term assets and other investments, not included in cash equivalent.

This activity involves the purchase and sale of long-term assets but for the consumption not for resale.

Investment includes investments that are not included in cash and cash equivalent such as current investment other than marketable securities.

Examples of investing activity:

Payment for purchase of fixed assets

Receipts from the disposal of fixed assets.

Payments to purchase securities i.e shares, bonds, debentures, warrants, etc.

Advances and loans.

Financing activity - Financing activity is the activity that results in a change in size and composition of the owner’s capital including preference share capital in the case of a company and borrowings of the enterprise from other sources.

Cash flow from financing activity is determined by analyzing the change in equity and preference share capital.

It is important to note that an increase in share capital due to bonus issues is not shown in the cash flow statement, because the company does not receive cash.

Example of financing activity: