Question

What is meant by cash flow ?

How cash flow analysis is performed ?

Also explain the advantages of cash flow analysis in a construction project

(write by Microsoft Word )

Answer 1

CASH FLOW : Cash flow is the net amount of cash that an entity receives and disburses during a period of time. A positive level of cash flow must be maintained for an entity to remain in business, while positive cash flows are also needed to generate value for investors. The time period over which cash flow is tracked is usually a standard reporting period, such as a month, quarter or year. Cash inflows come from the following sources:

Operations- This is cash paid by customers for services or goods provided by the entity.

Financing activities- An example is debt incurred by the entity.

Investment activities- An example is the gain on invested funds.

Methods of performing or preparing cash flow can be reported through two ways:

1.) Direct method- In the direct method, the major heads of cash inflows and outflows are to be considered ( such as cash received from trade receivables, employee benefits, expenses paid etc) are to be considered.

As the different line items are recorded on accrual basis in statement of profit and loss, certain adjustments are to be made to convert them into cash basis such as the following:

i. Cash receipts from customers = Revenue from operations + Trade receivables in the beginning - Trade receivables in the end.

ii. Cash payments to suppliers = Purchases + Trade payables in the beginning- Trade payables in the end.

iii. Purchases = Cost of revenue from operations - Opening inventory + Closing inventory.

iv. Cash expenses = Expenses on accrual basis+ Prepaid expenses in the beginning and outstanding expenses in the end - Prepaid expenses in the end and outstanding expenses in the beginning.

2.) Indirect Method: Indirect method of ascertaining cash flow from operating activities begjns with the amount of net profit/ loss. This is so because statement of profit and loss incorporates the effects of all operating activities of an enterprise. However, statement of profit and loss is prepared on accural basis. Moreover , it also includes certain non- operating items such as intrest paid, profit/ loss on sale of fixed assets etc. and non-cash items such as depreciatin, Goodwill to be written-off etc. Therefore , it becomes necessary to adjust the amount of net profit/ loss as shown by statement profit and loss for arriving at cash flows from operating activities.

Advantages of cash flow in construction projects are:

a) Cash flow statements help in knowing the liquidity/actual cash position of the company which funds flow and P&L are unable to specify.

b) As the liquidity position is known, any shortfalls can be arranged for or excess can be used for the growth of the project .

c) Any discrepancy in the financial reporting can be gauged through the cash flow statement by comparing the cash position of both.

d) Cash is the basis of all financial operations. Therfore, a projected cash flow statement will enable the management to plan and control the financial operations properly.

e) Cash flow analysis together with the ratio anaysis helps measure the profitability and financial positions of project.

f) Cash flow statement helps in internal financial management as it is useful in formulation of financial plans.