Cash and cash equivalents are the backbones of every business entity. There is nothing possible without cash.
So it is very essential to keep record of all the cash inflow to the organization and outflow from the organization should be kept in a proper way.
In small business entities, there are no such restrictions on the format of cash flow. But for large companies and organizations, there is a proper format to be followed.
The format is described in IAS-7 and GAAP (FAS95). For every business entity the statement of cash flow should be made according to these standards.
The main purpose of making a statement of cash flow is to provide the information and compare the cash receipts and cash payments during a time period in which the entity run their business.
It also serves the same purpose as preparing other financial statements is to let the users understand well about the entity’s financial situation only financial performance and position, but also the cash flow.
Classification of Statement of Cash flow:
According to IAS-7, the cash flow of every organization flows under the three main heads. It means all the transactions are should be classified under these three activities.
- Operating Activities
- Investing Activities
- Financing Activities
These are the main activities in an organization which are the reasons of changes come in cash and cash equivalents.
Each activity provide the different the information of entity’s cash flow with different purpose. Operating activities will let the users know whether the entity have the positive or negative cash flow as well as the movement of each items of working capital.
The purpose of preparing cash in the investing activities is to let the users know what are the items that entity has the hug investment in and what are the items that entity relax to invest.
Importance of Statement of Cash Flow:
Organizations using accrual methods of accounting to record their transactions. And all the financial statements are based on this information.
That’s why besides from statement of cash flow no financial report is providing the actual information about the cash inflows and outflows.
Let suppose an organization is running its business with high level of inventory and fixed assets along with high credit sales.
By analyzing balance sheet and Profit & loss statement you can say that the company is in a very stable position.
But on the other hand, there is not enough cash available to meet the expenses of the organization. Which may result in bankruptcy or decline in business of the company. Let’s study an example to understand it fully.
XYZ is running its business in New York City. The balance sheet shows Assets side $400,000 with a cash balance of $2000 and receivables amounting to $70,000. While the liability side shows payable of net $40,000.
Projected sales for the next month are amounting to $60,000 with an expected $50,000 credit sales. There is no chance of converting current receivables into cash.
If we analyze the above information we will say that company is in a very profitable mood with high sales. But when you make Cash current cash flow and projected cash flow for the next month it will say that there will be not enough money to pay current payables of $40,000.
So the managers have to adopt some strategy to counter the shortfall of cash. You can get this information only by statement of cash flow.
Cash flow for Decision Making:
In the previous example, we study how the cash flow statement is important for the company’s management to take their decisions and planning for the next business period. The cash flow statement is also important for the following persons
- To Investors:
To all the persons or organizations who want to invest in an organization. As it shows the company position to pay their current and long term payables. Investors value statement of cash flow the most when looking to invest in companies.
- To Creditors:
This report is always helpful to the creditors of a company. Because they use this report to decide whether it is feasible to go extent the credit limit of the company or should it be limit as the company cash flow shows negativity.So as part of the financial statements, It is equally important to all the stakeholders of an organization.