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Cash Flow Analysis

Cash plays a very important role in the entire economic life of a business. A firm needs a cash
to make payments to its suppliers, to incur day-to-day expenses and to pay salaries, wages,
interest and Dividends, EC. !n fact, what blood is to a human body, cash is to a business
enterprise. !t is very essential for a business to maintain an ade"uate balance of cash. #ut
many times, a concern operates profitability and yet it becomes very difficult to pay taxes and
dividends.
his may be because$
%& Although huge profits have been earned yet cash not have been received or
'& Even if cash has been received(
!t may have drained out )used& for some other purpose. his movement of cash is of vital
importance to the management.
A statement of changes in the financial position of firm on cash basis is called cash flow
analysis/statement. *uch a statement enumerates net effects of the various business
transactions on cash and takes into accounts receipts and disbursements of cash. A cash flow
statement summari+es the cause of changes in cash position of a business enterprise between
dates of two balance sheets.
Cash flow statement is a statement of changes of financial position in business due to inflow
or outflow of cash and their statement is re"uired for short-range business premises.
Advantages of Cash Flow Analysis
%& ,elps in efficient cash management
'& ,elps in internal financial management
-& Discloser the movements of cash
.& Discloses success or failure of cash planning
/& ,elpful in declaring dividends EC.
Helps in efficient cash management
Cash flow statement helps in evaluating financial polices 0 cash position, cash is the basis
for all operations and hence a pro1ected cash flow statement will enable the management to
plan and coordinate the financial operations properly.
Helps in internal financial management
Cash flow statement provides information about funds, which will be available from
operations. his will helps the management in determining policies regarding internal
financial management.
2or Example$ possibility of repayment of long-term debt, dividend policies, planning
replacement of plant and machinery, EC.
Discloser the movements of cash
Cash flow statement discloses the complete story of cash movement. he increase or decrease
in cash and the reason therefore can be known. !t disclose the reason for low cash balance in
spite of heavy operating profits or for heavy cash balance in spite of low profits.
,owever, comparison of original forecast with the actual results highlights the trends of
movement of cash, which may otherwise go undetected.
Discloses success or failure of cash planning
he extent of success or failure of cash planning can be known by comparing the pro1ected
cash flow statement with the actual cash flow statement and necessary remedial measures can
be taken.
Helpful in declaring dividends ETC.
Cash flow statement is very helpful in declaring dividends EC. his statement can supply
information regarding availability of cash. !f cash is available, dividend can be paid. hus, it
helps to understand the li"uidity. !t must be paid within .' days.
Disadvantages of Cash Flow Analysis
%& !gnores basic principal of accounting
'& 3ot suitable for 4udging profitability
-& Cannot be e"uated with income statement
.& 5ay not represent real li"uid position
Ignores asic principal of accounting
As cash flow statement is based on cash basis of accounting, it ignores the basic accounting
concept of accrual basis.
!ot suitale for "udging profitaility
Cash flow statement is suitable for 1udging the profitability of a firm, as non-cash charges are
ignored while calculating cash flow operating activities.
Cannot e e#uate with income statement
An income statement takes into account both cash as well as non-cash item and, therefore, net
cash does not necessarily mean net income of the business.
$ay not represent real li#uid position
he cash balance as disclose by the cash flow statement may not represent the real li"uid
position of the business since it can be easily influenced by postponing purchases and other
payments.


Cash Flow Analysis %A&'()
he institute of chartered accountants of !ndia has issued in %667 the accounting standard A*-
- )revised& relating to cash flow statement which has superseded A*-- issued earlier. As per
recent proposed format issued by the *E#! )securities Exchange #oard of !ndia& it is
mandatory for each company to give a copy of its cash flow statement along with its final
accounts.
he cash flow statement can be classified into following activities$
%& 8perating activities
'& !nvesting activities
-& 2inancing activities
An enterprise presents its cash from operating, investing 0 financing activities in a manner
which is most appropriate to its business. Classification by activities provides information
that allows users to assess the impact of those activities on the financial position of the
enterprise and the amount of its cash and cash e"uivalents. his information may also be used
to evaluate the relationship among those activities.
A single transaction may include cash flow that are classified differently.
2or Example$ when the instalment paid in respect of a fixed asset, ac"uired on deferred
payment basis includes both interest 0 loan, the interest element is classified under financing
activities and the loan element is classified under investing activities.

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