Completion of Cash Flow Statements

Definition

A Cash Flow Statement gives a detailed account of how a company generates and uses cash in a given period. It’s broken down into three sections: operating activities, investing activities, and financing activities.

Purpose

Provides stakeholders with a clear understanding of a company’s ability to generate cash.
Reveals the company’s capacity to pay dividends and meet obligations.
Shows the cash implications of business operations, not just the profit or loss.

Sections of a Cash Flow Statement

Operating Activities: This section shows the cash generated from the main activities of the business, such as sale of goods or services.
Investing Activities: This portion displays the cash used or generated from investing in the long-term future of the business, such as the purchase or sale of assets.
Financing Activities: In this area, cash transactions related to changes in size and composition of the company’s capital are shown, such as issue of shares or payment of dividends.

Method of Preparation

Direct Method: This method entails listing out cash receipts and payments occurring in the period. It is more detailed and hence provides better insights. However, it can be time-consuming to prepare.
Indirect Method: This begins with net profit and adjusts for non-cash and non-operational items, then considers changes in balance sheet items. It is easier to compute and thus more commonly used.

Importance of Cash Flow Statements

Liquidity Assessment: Reveals the company’s ability to pay off its debts as they come due.
Cash Planning and Control: Helps in planning future cash flows and control over cash.
Judgement About Financial Structure: Provides information for judging the company’s ability to return borrowed capital, pay dividends, and optimize the use of financial resources.

Limitations of Cash Flow Statements

Not a Substitute for Income Statement or Balance Sheet: Cash flow statements provide additional insights but do not replace the profit and loss account or balance sheet.
Does Not Reflect the Entire Financial Health: A company with strong cash flows can still have poor profits. Therefore, it is important to consider other financial statements as well.
No Projection for Future: Cash flow statements are based on the past. They do not necessarily indicate future cash flows.