Question

Discuss the interrelationship of the cash flow statement to the other financial statements. In your discussion comment and explain operating activities, investing activities, and financing activities. What is the difference between an indirect and a direct cash flow statement? Which is GAAP?

(250 words total and no plagiarirm please)

Answer 1

Cash Flow Statement :-

A Cash flow statement shows inflow and outflow of cash and cash equivalents from various activities of a company during a specific period. The primary objective of cash flow statement is to provide useful information about cash flows (inflows and outflows) of an enterprise during a particular period under various heads i.e., operating activities, investing activities and financing activities.

Classification of Activities for the Preparation of Cash Flow Statement

1) Cash from Operating Activities:- Cash flows from operating activities are primarily derived from the main activities of the enterprise. They generally result from the transactions and other events that enter into the determination of net profit or loss. Examples of cash flows from operating activities are:

Cash Inflows from operating activities

• cash receipts from sale of goods and the rendering of services.
• cash receipts from royalties, fees, commissions and other revenues.

Cash Outflows from operating activities

• Cash payments to suppliers for goods and services.
• Cash payments to and on behalf of the employees.
• Cash payments to an insurance enterprise for premiums and claims, annuities, and other policy benefits.
• Cash payments of income taxes unless they can be specifically identified with financing and investing activities.

The net position is shown in case of operating cash flows

2) Cash from Investing Activities:- Separate disclosure of cash flows from investing activities is important because they represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. Examples of cash flows arising from investing activities are:

Cash Outflows from investing activities:

• Cash payments to acquire fixed assets including intangibles and capitalised research and development.
• Cash payments to acquire shares, warrants or debt instruments of other enterprises other than the instruments those held for trading purposes.
• Cash advances and loans made to third party (other than advances and loans made by a financial enterprise wherein it is operating activities).

Cash Inflows from Investing Activities:

• Cash receipt from disposal of fixed assets including intangibles.
• Cash receipt from the repayment of advances or loans made to third parties (except in case of financial enterprise).
• Cash receipt from disposal of shares, warrants or debt instruments of other enterprises except those held for trading purposes.
• Interest received in cash from loans and advances.
• Dividend received from investments in other enterprises.

3) Cash from Financing Activities:- Separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of funds ( both capital and borrowings ) to the enterprise. Examples of financing activities are:

Cash Inflows from financing activities:

• Cash proceeds from issuing shares (equity or/and preference).
• Cash proceeds from issuing debentures, loans, bonds and other short/long-term borrowings.

Cash Outflows from financing activities:

• Cash repayments of amounts borrowed.
• Interest paid on debentures and long-term loans and advances.
• Dividends paid on equity and preference capital.

It is important to mention here that a transaction may include cash flows that are classified differently. For example, when the instalment paid in respect of a fixed asset acquired on deferred payment basis includes both interest and loan, the interest element is classified under financing activities and the loan

element is classified under investing activities. Moreover, same activity may be classified differently for different enterprises. For example, purchase of shares is an operating activity for a share brokerage firm while it is investing activity in case of other enterprises.

CASH FLOW STATEMENT VS FUND FLOW STATEMENT

The main points of difference between funds flow statement and cash flow statement are as follows.

(1) A cash flow statement shows only the changes in cash position, whereas a funds flow statement shows changes in working capital position between two balance sheet dates. Cash is only one of the elements of working capital. Therefore, a funds flow statement has a wider coverage than a cash flow statement.

(2) A cash flow statement is merely a record of cash receipts and payments. It is no doubt useful but it does not show many important changes involving the disposition of resources. In studying the short-term solvency of a firm one is interested not only in cash balance but also in the assets which are easily convertible into cash. Funds flow statement provides information about such assets.

(3) Cash flow statement is more useful to the management as a tool of financial analysis in short term. Funds flow statement is more useful in long-term.

(4) Cash is a part of working capital. Therefore, an improvement in cash position results in an improvement in the funds position. An inflow of funds may not result inflow of cash. In other words, a sound cash position generally means a sound funds position but a sounds funds position does not necessarily mean a sound cash position.

(5) The technique of preparing a funds flow statement is different from the technique of preparing a cash flow statement. An increase in the current liability or a decrease in a current asset results in an outflow of funds. But an increase in current liability or decrease in current assets (other than cash) does not result in cash inflow.