Question

Discuss the Statement of Cash flow elements and how to interpret each element in relation to the other financial statements of a corporation. When is net cash out flow from operations a good thing? When is net cash outflows from investing a good thing? When is net cash outflow from financing a good thing? When answering these questions, keep in mind the relation to the other statements of the corporation

Answer 1

Statement of cash flow

Step-1: Importance of cash flow statement:

• Cash flow statement will helpful to company to estimate the liquidity position and short term viability of the company.
• Improve the comparability of different firms operating performance by eliminating the effects of different methods.
• It also useful to determine the cash flows to the firm ,periodicity and amount.

Step-2: Components/Categories of cash flow statement

• Operating activities: This session comprises of cash generated or used by company business operations. This includes earnings delivered by the company and amount collected from customers.
• The sources and uses of cash in the operating section come from revenue, expenses, gain, losses and other costs.
• Cash flow from operating activities will equal to Net income + Depreciation and Amortisation-changes in operating working capital.\

• Investing activities: The cash generated/used by a company’s investment in assets. cash flow from financing activities includes the purchase of fixed assets and maintenance of those assets (capital expenditures), payments made for acquisition activities, cash generated by sale of securities and non- operating uses of cash.
• These activities are represented in the investing income as a part of income statement.

• Financing activities: The cash generated/used by the company’s financing of its operations.
• Cash flow from financing activities includes cash flows from shareholders and lenders as well as the outflows of dividend or sale of stocks.
• This part comprises of cash proceeds from borrowings and repayment of debts, cash collection of common stock and cash repayment of common stock.

Step-3: Relationship of each element in relation to other financial statement:

• In order to prepare the cash flow statement we must analyse the balance sheet, Income statement of the period under preparation.
• If entity is following accrual basis of accounting then we should look into cash components.
• Cash flow analyst should focus on changes in the account balances on balance sheet.
• While preparing the cash flow statement we should understand whether the item in financial statement is cash inflow or cash outflow.
• The rules for these process is:
• Transactions that result in an increase in assets will always result in a decrease in cash flow.
• Transactions that result in a decrease in assets will always result in an increase in cash flow.
• Transactions that result in an increase in liabilities will always result in an increase in cash flow.
• Transactions that result in a decrease in liabilities will always result in a decrease in cash flow.

Step-4: Net cash out flow from operations:

• As discussed above cash flow from operating activities means cash generated/used by entity in the operations.
• Net cash ouflow from operations means the payments for procuring produsts /services are more than the cash generated (Sale proceeds/services receipts).
• Negative cash flows does not necessarily mean a company is not performing well.
• Cash flow from operations describes the company performance relative to amount of cash it currently has on hand to cover the operating expenses. It is different from Profit and loss account and income statement.
• To cover up the cash deficiency the company should bring cash using financing activities.
• Net cash outflow from operations is good when the company is able to get funds through financing activities at lesser rate than the company’s opportunity cost of capital.

Step-5: Net cash flow from investing activity:

• Negative cash flow from investing activity may not necessarily the company performance is poor.
• When the capital expenditure (investment in fixed assets) is more nothing but it represents the company which is investing more in fixed assets represents long term growth in the company performance.
• Further the assets or investment value in the balance sheet increases.Financial position of the company is good.

Step-6: Net cash outflow from financing activities:

• Net cash outflows from financing activities means either the company is not raised any funds through financing sources or Debt service of company is more than what the amount raised through financing methods.
• Further it also means payment of dividend or stock repurchases which the investors feel happy. If the negative cash outflow is due to payment of dividend to owners then the situation may be good for the company as it leads to investors satisfaction.