Importance of Cash Flows statement (A Brief Note)

What is the importance of cash flows statement?

Importance of Cash Flows statement (A Brief Note)
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Cash Flow Statement is beneficial as it helps in keeping record of various cash investments right from the beginning till the end. It is an important financial tool that helps in making various financial forecasts. The underlying article explains in detail the importance of cash flows statement.

Paradoxically a situation arises when profits are reported but negative cash flows are experienced by the business entities. Therefore, it is of the essence that the changes in cash position be depicted; to know the cash concepts that the statement of cash flows is based upon; to get the information about the cash receipts and the cash payments during a period. Also, it is necessary to assess the ability of a business entity to generate cash so that it can be used as and when it is needed. Moreover, it is required to assess the liquidity and solvency position of a business. Thus, the preparation of cash flow statement is very much useful to management. It is one of the three main financial statements (Balance Sheet, Income Statement and the cash flow statement).

The cash flow statement is an important tool as it explains the changes in cash and gives the information related to the business operating, investing and financing activities in a way to bring advantage to short term analysis and cash planning of the business.

The basic objective of cash flow statement is to provide the information to the management about the cash receipts and the cash payments of an organization and it is used in efficient cash management as well.

Since one of the important functions of a financial manager is cash management and to ensure if adequate cash is available to meet the liabilities, it is owing to the cash flow statement that the related information is derived. Cash flow statement is useful to plan financial operations in an efficient manner.

Cash flows are inflows and outflows of cash and cash equivalents. The cash activities are classified into three main categories of cash inflows and cash outflows. The tree categories are:-

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

Operating Activities:- They are revenue generating activities of the business entity. They include cash effects of transactions by which Net profit or loss is determined.

For example; a few of the operating activities are mentioned below:

  • Cash receipts from the sale of goods and providing services.
  • Cash receipts from commissions, fees or other revenues.
  • Cash payment to suppliers for goods and services.
  • Cash payments to employees.
  • Dividends received

Investing Activities:- Investing activities are those that involve the acquisition and selling fixed assets.(Land, building and equipments) not held for resale. Below mentioned are few of investing activities:-

  • Cash payments to acquire fixed assets.
  • Cash receipts from the disposal of fixed assets
  • Acquiring and disposal of stock from third parties.
  • Making and collecting loans to third parties.

Financing Activities:- These activities are the activities by which the size and the composition of owners capital is changed. They are as follows:-

  • Cash proceeds from issuing shares.
  • Cash proceeds from the issuance of debt, loans and short term borrowing.
  • Treasury stock transactions.
  • Payments of dividends.

Brief overview on the preparation of Statement of Cash flows:

Cash flow statement can be prepared by two methods, direct and indirect method. Both methods are acceptable under US GAAP. Both methods provide the same results inasmuch as the direct method differs from the other in the presentation of operating activities. In order to prepare the statement of cash flows, balance sheet at the beginning and at the end of the period are needed as the changes related to assets, liabilities and capital can be determined. The income statement of the current year is used to provide the information about the operations by making the adjustments to the non-cash items. Besides, additional data is collected to know how cash has been used. The statement of cash flow is a better tool of analysis as cash is more important than working capital and the cash flow statement provides the information about generating cash. It is through the statement of cash flows that the health and efficiency of a business entity is determined while it enables to assess the liquidity and solvency position of a business.

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