It has three different components in which all the changes are written down. There are two methods of making cash flow statement.
- Direct Method
- Indirect Method
The internal Accounting standards prefer the direct method for preparation of statement of cash flow. But some organizations also use indirect method for their cash flow statement. The cash flow statement is divided in three parts. Which are
- Cash flow from Operating Activities
- Cash flow from Investing Activities
- Cash flow from Financing Activities
Net cash flow from these activities are net up with the profit/ loss value taken from the income statement.
And at the end previous balance of cash in hand in added up to determine the ending balance of cash. This statement also verify that the organization cash activities are free from errors and frauds.
Description Of Each Activity:
The operating activity is mostly made by the information gather from the current section of balance sheet.
It involves the changes from current receivables, current payable and inventory. These all are sum up to get the amount of cash flow generated from operating activities.
The investment activities involves the cash inflow and outflow of cash related to investment activities taken place in the period. These may include purchasing or selling of a fixed asset.
Financing Activities are generated from the changes in liabilities and capital side of the balance sheet.
The amount is positive if the activity generate cash inflow and negative when there is an outflow of cash due to the said activity.
Effect Of Negative and Positive Cash Flow:
The cash flow coming from each activity sometimes result positive and sometime give negative result. It is not necessary that the outcome of cash flow from any activity must be positive.
Because it depends on the strategy of the business carried out by the management. Suppose if the company acquire loans or issue shares to the market.
It results in the positive cash flow. And when company boost their sales by offering credit to the market or increase their inventory level due to some reasons then it is possible that the cash flow from operating activities becomes negative.
Similarly the case is with the investing activities. If the company make purchase some fixed assets then the cash flow from investing activities may goes negative.
Is Negative Cash Flow From Investing Activities is bad?
Cash flow from investing activities is affected by selling and purchasing of any fixed asset of the company.
When the company buy any fixed asset during the period, it affects the cash flow negatively because there is an outflow of cash from the organization.
It is absolutely very normal activity because when u look at the balance sheet. The current asset is converted to a long term asset. The journal entry can give you more information about.
For Example. A company acquire a recycling plant worth $200,000 and paid full in cash.
The entry will be:
Plant A/c $200,000
Cash A/c $200,000
It means that there is an outflow of cash $200,000 from the organization cash account.
The effect of this transaction in the cash flow statement will be like ($200,000) but by analyzing you can determine that only the company’s current asset is converted into Long term asset.
So we can say that the negative balance in very much positive in its effect. Because it gives increase in the company’s Fixed Asset. Which is useful for the company in the long run.