Cash Flow Statement: Explanation, Classification, and Objectives

What does Cash Flow Statement mean? A cash flow statement counters the ambiguity regarding a company’s solvency that various accrual accounting measures create. We are studying Cash Flow Statement: Explanation, Classification, and Objectives; In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.

Here explains the Concept of Cash Flow Statement with their Explanation, Classification, Objectives, and Limitations.

The following concept is; Explanation of Cash Flow Statement, Classification of Cash Flow Statement, Objectives of Cash Flow Statement, and Limitations of the Cash Flow Statement. Meaning: A Cash Flow Statement is a statement which is prepared by acquiring Cash from different sources and the application of the same for different payments throughout the year. It is prepared from analysis of cash transactions, or it converts the financial transactions prepared under accrual basis to cash basis.

The information about the number of resources provided by operating activities or net income after the adjustment of certain other charges can also obtain from it. The changes in Cash both at the beginning and at the end can also know with the help of this statement and that is why it is called Cash Flow Statement.

#Explanation of Cash Flow Statement:

A cash flow statement is an important indicator of financial health because a company can show profits while not having enough cash to sustain operations. It is a financial report that shows to the user the source of a company’s cash and how it was spent over a specific period. A cash flow statement counters the ambiguity regarding a company’s solvency that various accrual accounting measures create.

It also categorizes the sources and uses of cash to provide the reader with an understanding of the amount of cash a company generates and uses in its operations. As opposed to the amount of cash provided by sources outside the company. Such as borrowed funds or funds from stockholders. They also tell the reader how much money was spent on items that do not appear on the income statement. Such as loan repayments, long-term asset purchases, and payment of cash dividends.

The cash flow statement was previously known as the flow of funds statement. The cash flow statement reflects a firm’s liquidity. The balance sheet is a snapshot of a firm’s financial resources and obligations at a single point in time, and the income statement summarizes a firm’s financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues.

Extra Knowledge:

They include only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a few. It is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Non-cash activities are usually reported in footnotes.

It is intended to provide information on a firm’s liquidity and solvency and its ability to change cash flows in future circumstances provide additional information for evaluating changes in assets, liabilities, and equity improve the comparability of different firms’ operating performance by eliminating the effects of different accounting methods indicate the amount, timing and probability of future cash flows. The cash flow statement has been adopting as a standard financial statement because it eliminates allocations, which might derive from different accounting methods, such as various time-frames for depreciating fixed assets.

#Classification of Cash Flow Statement:

The cash flow statement should report cash flows during the period classification by operating, investing and financing activities.

Thus, cash flows are classifying into three main categories:

1. Operating activities.
2. Investing activities.
3. Financing activities.

Now, explain;

Operating Activities:

Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise, pay dividends, repay loans, and make new investments without recourse to external sources of financing.

Information about the specific components of historical operating cash flows is useful, in conjunction with other information, in forecasting future operating cash flows. Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the enterprise. Therefore, they generally result from the transactions and other events that enter into the determination of net profit or loss.

Explanations:

Examples of cash flows from operating activities are:

• A cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits.
• Cash receipts from the sale of goods and the rendering of services.
• Cash receipts from royalties, fees, commissions, and other revenue.
• The cash payments to suppliers of goods and services.
• Cash payments to and on behalf of employees.
• Refunds or cash payments of income taxes unless they can specifically identify with financing and investing activities, and.
• Cash receipts and payments relating to futures contracts, forward contracts, option contracts, and swap contracts when the contracts are heling for dealing or trading purposes.

Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which includes in the determination of net profit or loss. However, the cash flows relating to such transactions are cash flows from investing activities.

Investing Activities:

Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been making for resources intended to generate future income and cash flows.

Explanations:

Examples of cash flows arising from investing activities are:

• The cash payments to acquire fixed assets. These payments include those relating to capitalized research & development costs and self-constructed fixed assets.
• Cash receipts from the disposal of shares, warrants, or debt instruments of other enterprises and interests in the joint venture.
• Cash advances and loans made to third parties, other than advances and loans made by a financial enterprise.
• The cash receipts from disposal of fixed assets.
• Cash receipts from the repayment of advances and loans made to third parties, other than advances and loans of a financial enterprise.
• Cash payments to acquire shares, warrants, or debt instruments of other enterprises and interests in joint ventures. Other than payments for those instruments considering to be cash equivalents and those held for dealing or trading purposes.
• The cash payments for futures contracts, forward contracts, option contracts, and swap contracts except when the contracts are heling for dealing or trading purposes, or the payments are classifying as financing activities, and.
• Cash receipts from futures contracts, forward contracts, option contracts, and swap contracts except when the contracts are heling for dealing or trading purposes or the receipts are classifying as financing activities.

Financing Activities:

Financing activities are activities that result in changes in the size and composition of the owner’s capital and borrowings of the enterprise. The separate disclosure of cash flows arising from financing activities is important because .it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise.

Explanations:

Examples of cash flows arising from financing activities are:

• Cash proceeds from issuing shares or other similar instruments.
• Cash proceeds from issuing debentures, loans, notes, bonds, and other short-or long-term borrowings, and.
• The cash repayments of amounts borrowed such as redemption of debentures, bonds, preference shares.

#Objectives of Cash Flow Statement:

The primary objectives of the cash flow statement are to supply the necessary information relating to the generation of cash to the users of the financial statement. It also highlights the future or prospective cash positions i.e. cash or cash equivalent. The inflows and outflows of cash can represent with the help of this statement.

The main objectives of the cash flow statement are:

Measurement of Cash:

Inflows of cash and outflows of cash can measure annually. Which arise from operating activities, investing activities and financing activities.

Generating inflow of Cash:

Timing and certainty of generating the inflow of cash can know. Which directly helps the management to take financing decisions in the future.

Classification of activities:

All the activities are classifying into operating activities, investing activities and financing activities. Which help a firm to analyze and interpret its various inflows and outflows of cash.

Prediction of the future:

A cash flow statement, no doubt, forecasts the future cash flows. Which help the management to take various financing decisions since synchronization of cash is possible.

Supply necessary information to the users:

A cash flow statement supplies various information relating to inflows and outflows of cash to the users of accounting information in the following ways:

• Assess the ability of a firm to pay its obligations as soon as it becomes due.
• Analyze and interpret the various transactions for future courses of action.
• To see the cash generation ability of a firm, and.
• Ascertain the cash and cash equivalent at the end of the period.

Helps the management to ascertain cash planning:

No doubt, a cash flow statement helps the management to prepare. Its cash planning for the future and thereby avoid any unnecessary trouble.

Evaluation of future cash flows:

Whether the cash flow from operating activities is quite sufficient in the future to meet the various payments e.g. payment of expense/debts/dividends/taxes.

Assessing liquidity and solvency position:

Both the inflows and outflows of cash and cash equivalent can know, and as such, liquidity and solvency position of a firm can also maintain as timing and certainty of cash generation knows i.e. It helps to assess the ability of a firm to generate cash.

#Limitations of the Cash Flow Statement:

Despite several uses, the cash flow statement suffers from the following limitations:

• As the cash flow statements based on the cash basis of accounting. It ignores the basic accounting concept of accrual basis.
• A cash flow statements, not a substitute for an income statement it is complementary to an income statement. Net cash flow does not mean the net income of a firm.
• A cash flow statement is also not a substitute of funds flow statement which. Provides information relating to the causes that lead to an increase or decrease in working capital.
• The comparative study of cash flow statements may give misleading results.
• Some people feel that as working capital is a wider concept of funds. A funds flow statement provides a more complete picture than the cash flow statement, and.
• Cash flow statements not suitable for judging the profitability of a firm as non-cash charges are ignored while calculating cash flows from operating activities.