Question

A cash flow statement is considered a major financial statement for a business and nonprofit entity. After studying resources, discuss the main purposes of a cash flow statement and how an entity uses the cash flow statement. Next, discuss the major sections of a cash flow statement and identify which types of transactions are contained in each section.

Answer 1

A Cash flow statement is an important part of the financial statements published by reporting firms. A Cash flow statement summarizes the movement of cash from opening balance to closing balance and understanding whether movement is due to operating, investing and financial activity. Most of the regulatory requirements today have made Cash flow statement mandatory to publish along with its Financial Statements. A Cash flow statement can help stakeholders in making informed decisions regarding their investments.

The main purpose of cash flow statement and how entity uses it is summarized below

· Helps in understanding working capital movement due to operating activities.

· Helps in raising capital and investment decisions like purchase of fixed assets for future growth of business.

· Helps in understanding the financial cash position of the firm and to ascertain its cash flow from operating, investing and financing activities

· Helps in arranging long term finance based on the forecast of cash flow through bonds , debts, bank borrowings, etc

· Helps in taking short term decisions regarding financial requirements like short term notes or bank borrowing

· Helps in managing cash which is pivotal to any business. A business which is well managed with cash will rarely find solvency related issues

· Helps in understanding free cash flows available to shareholders

Major sections of Cash flow statement

1. Cash flow from Operating activities

2. Cash flow from Investing activities

3. Cash flow from Financing activities

4. Non cash investing and financing activities

Cash flow from operating activities

· Non cash expenses, losses and gains are added back- Depreciation ,gain and loss on sale of assets and investments, discount amortization, etc

· Movements in Current assets and Current liabilities are part of cash flow – Like Accounts receivable, accounts payable, inventories, accrued expenses, interest payable, income tax payable, etc

· In direct method it is –cash collected from customers, payments to suppliers, payment for operating expenses, interest and income tax

Cash flow from investing activities is usually associated cash flow from sale and purchase of investments, fixed assets

Cash flow from financing activities is usually associated with issue of new equity, dividend paid, treasury shares purchased, borrowing and repayment of loans, etc

Non cash investing and financing activity – This section contains non cash transactions which needs disclosure for example purchase of assets for non cash consideration like issue of long term note or issue of common shares.