Definition

A cash flow statement monitors the inflow and outflow of cash, providing information on a company's financial health and operational efficiency.

Description

Cash flow statement is also known as the statement of cash flows.

The CFS assesses how well a company manages its cash position or generates cash to meet debt commitments and support operating expenses. The CFS, one of the three primary financial statements, supplements the balance sheet and income statement. 

• A cash flow statement summarises the cash and cash equivalents that enter and leave an organisation. 
• The Cash Flow System shows a company's cash management, especially its ability to create cash. 
• This financial statement supplemented the balance sheet and income statement. 
• The Cash Flow Statement mainly comprises operating, investing, and financing cash generated.
• There are two approaches for calculating cash flow: direct and indirect.
  
   

Importance of Cash Flow Statement

This is why the cash flow statement is important:

The cash flow statement is a significant financial document that gives information about a company's liquidity, solvency, and general economic health. Here are some essential factors that emphasise its importance:
 

• Liquidity Analysis: The cash flow statement assesses the company's capacity to satisfy its short-term obligations by detailing cash inflows and outflows. It clearly shows how much cash is accessible at any time, which is critical for day-to-day operations.
• Financial Health Assessment: Unlike the income statement and balance sheet, which may include non-cash items, the cash flow statement only considers cash transactions. This makes it a trustworthy predictor of a company's current cash situation and potential to earn cash from its core business activities.
• Investment Decision Making: Investors and creditors use the cash flow statement to assess the company's ability to generate positive cash flows over time. A good cash flow indicates that the company may reinvest in its operations, pay dividends, or pay down debts, making it an appealing investment prospect.
• Predicting Future Performance: By evaluating past cash flow patterns, stakeholders can make more accurate projections about a company's future cash flows. This information is helpful for strategic planning, budgeting, and establishing realistic financial objectives.
• Detection of Financial Issues: A cash flow statement can identify potential financial difficulties such as falling cash reserves, consistent negative cash flows, or cash management anomalies. Identifying these concerns early on enables management to take corrective action to avert financial difficulties or insolvency.

How is cash flow calculated?

There are two ways to calculate cash flow: direct technique and indirect method.

Direct Cash Flow Method.

The direct method adds all cash payments and receipts, including cash paid to suppliers, cash received from consumers, and cash paid out as salary. This CFS form is more straightforward for small enterprises that employ the cash-based accounting approach.

These statistics can also be obtained by comparing the beginning and ending balances of various asset and liability accounts and determining the net loss or growth. It is provided in an introductory manner.

Indirect Cash Flow Method

The indirect method determines cash flow by changing net income to include or exclude differences from non-cash transactions. Non-cash items are reflected in changes to a company's assets and liabilities on the balance sheet from one period to the next. As a result, the accountant will identify any changes and decreases in asset and liability accounts that must be added to or subtracted from the net income figure to calculate an accurate cash inflow or outflow.

Changes in accounts receivable (AR) on the balance sheet from one accounting period to the next must be reflected in cash flow:

• If AR decreases, more cash may have entered the company from customers paying off their credit accounts—the amount AR has decreased is then added to net earnings.
• An increase in AR must be deducted from net earnings because, although the amounts represented in AR are in revenue, they are not cash.

Trends that affect cash flow statement operating activities

Some of the trends that can affect the cash flow operating activities include:

Sales Growth: Increased sales often result in larger cash inflows from operating activities since core business operations create more revenue.

Changes in Accounts Receivable: An increase in accounts receivable shows that sales were made on credit, which may result in delayed cash receipts. A decrease in accounts receivable may indicate greater cash collection efficiency.

Inventory Management: Effective inventory management has an impact on cash flows. Inventory levels may decrease, indicating greater sales and less cash tied up in unsold goods, but rises may signal slower sales or overstocking.

Changes in accounts payable: Accumulated expenses impact cash flows. Increases in these accounts benefit short-term cash by deferring payments to suppliers and creditors.

Operating Expenses: Changes in operating expenses, such as salary, rent, utilities, and administrative costs, affect cash flows. Increased expenses limit cash available for various purposes, whilst cuts can enhance cash flow.

Non-Cash Expenses: Non-cash expenses include depreciation and amortisation, which affect net income but do not entail cash withdrawals. Adjusting for these expenses is required to appropriately portray cash flows from operating operations.

Example
 

-----------------------------------------------------+

|                   XYZ Corporation                     |

|                Cash Flow Statement                    |

|         For the Year Ended December 31, 2023          |

+-------------------------------------------------------+

|                  Operating Activities                 |

+-------------------------------------------------------+

| Net Income                              | ₹50,000      |

| Depreciation                            | ₹10,000      |

| Changes in working capital:             |              |

|   Increase in accounts receivable       | (₹5,000)     |

|   Increase in accounts payable          | ₹8,000       |

| Net Cash Provided by Operating Activities | ₹63,000     |

+-------------------------------------------------------+

|                  Investing Activities                 |

+-------------------------------------------------------+

| Purchase of equipment                   | (₹20,000)    |

| Sale of investments                     | ₹15,000      |

| Net Cash Used in Investing Activities   | (₹5,000)     |

+-------------------------------------------------------+

|                  Financing Activities                 |

+-------------------------------------------------------+

| Issuance of long-term debt              | ₹30,000      |

| Repayment of short-term debt            | (₹10,000)    |

| Net Cash Provided by Financing Activities| ₹20,000      |

+-------------------------------------------------------+

|                   Net Increase in Cash                |

+-------------------------------------------------------+

| Net Increase in Cash                    | ₹78,000      |

| Beginning Cash Balance                  | ₹20,000      |

| Ending Cash Balance                     | ₹98,000      |

+-------------------------------------------------------+

FAQ

How is a cash flow statement different from an income statement and balance sheet?

While an income statement reports revenues and expenses over a period to determine net income or loss, and a balance sheet provides a snapshot of a company's financial position at a specific point in time, a cash flow statement focuses solely on cash inflows and outflows during a period, regardless of when transactions occurred.
 

What does a positive or negative cash flow indicate?

A positive cash flow means that a corporation makes more cash than it spends, which is generally regarded as good. A negative cash flow indicates that a corporation spends more than it generates, which could indicate financial difficulties or investment in growth opportunities.

How can investors and creditors use a cash flow statement?

A cash flow statement is used by investors and creditors to evaluate a company's capacity to earn cash, meet financial obligations, and continue operations. It enables them to assess the company's financial performance and make informed judgments about investments or lending.

What are some limitations of the cash flow statement?

While a cash flow statement gives valuable information about a company's cash position, it has limits. It excludes non-cash expenses like depreciation and may not accurately reflect future cash flows because it only gives information for a current time. It may also require the capture of all cash equivalents or off-balance-sheet transactions.