In: Accounting
Team, what is communicated on the face of the statement of cash flows and related disclosures? Why might this be important to an investor or creditor? Brandy
General Purpose Financial Statements include
a. Balance Sheet / Posistion Statement which depicts the status of
business i.e., assets and liabilities at a point of time.
b. Income Statement which shows the performance of business i.e.,
profit or loss for the period.
Book-keping and accounting is done on accrual basis of
accounting.
Because of accrual basis, the actual cash receipts and payments
cannot be traced from the general purpose financial
statements.
Hence, for the better understanding of cash flow in and out of
business entity, cash flow statement is being presented.
Thus, cash flow stataemnt presents movement of cash.
There are two methods of disclosure of Cash Flow
Statement:
1. Direct Method
2. Indirect Method
Under direct method, cash flow statement is presented as Sources
and Application of Funds during the year.
Cash inflow from every source (ledger wise) is presented under
Sources.
Cash outflow for every application (ledger wise) is presented
underr Applications.
Under Indirect method, cash flow statement presents the movement
of cash during the year resulting from operating, investing and
financing activities of the company.
In this method, profit before tax is adjusted for the effects of
transactions of a non-cash nature, any deferrals or accruals of
past or future operating cash receipts or payments and item of
income or expenses associated with investing or financing cash
flows.
Thus, details communicated on face of Cash flow statement is
determined by the method under which cash flow statement is
presented.
Under direct method, Sources (gross cash receipts) and Applications
(gross cash payments) are presented as a whole of business for the
year.
Under indirect method, cash inflows and outflows are catagorised
into operating activities, investing activities and financing
activities.
Associated Discclosures for cash flow statement prescribed under
accounting standards are:
1. significant cash and cash equivalents held by business entity
that are not available for use.
2. amount of undrawn balance in borrowing facility available for
future operating activities.
Users of financial statements can understand how the enterprise
generates and uses cash and cash equivalents.
A potential investor or creditor will analyse net cash flows
through operations exceeds net cash flows from selling assets or
borrowing money. This is because selling assets or borrowing money
can never be construed as a continuing event, such as bringing in
cash from selling goods or services. Thus, indirect method is most
popularly used to present cash flow statement.
Uses of Cash
Flow statement:
Investor: An investor wants to make sure the entity has
enough cash flow to pay an adequate return on investment. In other
words, investor expects getting a cash dividend. Also important is
using the statement of cash flows to evaluate how well the company
is managing its cash because investors may eventually sell their
shares of stock. If the company mismanages its cash to such a point
that it goes out of business, there won’t be any buyers for the
company’s stock — the stock may be worthless.
Creditor: The creditor is interest in company's liquity and has sound cash management. After all, in addition to interest expenses, the creditor wants to make sure it also gets paid back the principal portion of the loan. It’s never a good sign if a business is paying back debt by assuming more debt or issuing more equity.