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Cash flow analysis

Meaning
Cash flow signifies the movements of cash in and out of a business concern. While the
inflow of cash is a source of cash, the outflow of cash is a use of cash. Thus a cash flow
statement is a statement of changes in the financial position of firm on cash basis. It
summarises the causes of changes in cash position of a business concern between two
balance sheet dates and enumerates the net effects of various business transactions on
cash.

Distinction between cash flow statement and funds flow statement:


The difference between cash flow statement and funds flow statement are as follows:
1. Cash flow statement is based on a narrower concept of funds, i.e., cash which is
only one of the components of working capital. But funds flow statement is based
on a wider concept of funds, i.e., working capital.
2. Cash flow statement is based on cash basis of accounting, while funds flow
statement is based on accrual basis of accounting.
3. No schedule of working capital changes is prepared in cash flow statement. But
in the case of funds flow statement, a schedule of changes in working capital is
prepared to show the changes in current assets and current liabilities.
4. Cash flow statement is concerned with changes in cash position only. But funds
flow statement is concerned with the changes in working capital between two
balance sheet dates.
5. Cash flow statement is prepared with opening balance as starting point and ends
with closing balance. But no such opening or closing balance appears in funds
flow statement.
6. Cash flow statement is useful for short -term analysis and cash planning. But
funds flow statement is useful in planning intermediate and long-term financing.
Utility and significance of cash flow statement:
Being a tool of financial analysis for short-term planning, the cash flow statement
possesses the following advantages and utilities:

1. Cash flow statement is highly useful for the evaluation of the cash position
of the cash position of the concern as it is based on the cash basis of
accounting.
2. It is highly useful and appropriate for short-term financial planning.
3. It helps the management to evaluate the ability of the concern to meet its
obligations such as payment of creditors, repayment of bank loan,
payment of interest, taxes and dividends etc.
4. The trend of a firms liquidity can be determined with the help of a series of
intra-firm and inter-firm cash flow statements.
5. It helps for making appraisal of various capital investments projects just to
determine their viability and profitability.
6. It is highly useful to external analysts like bankers for reviewing the
financial position of the borrowers.
7. It is used to explain the anomaly of substantial profits and poor cash
position.
Limitations of Cash Flow Statement:
In spite of a number of uses, cash flows statement suffers from the following drawbacks:
1. Although cash flow statement reveals the inflow and outflow of cash, it excludes
the near cash items from cash. This obscures the true reporting of the firms
liquidity position.
2. The term cash cannot be precisely defined. There are controversies over a
number of items such as cheques, stamps, postal orders etc., to be included in
cash.
3. Cash flow statement is not a substitute for income statement as both of them
have separate functions to perform.
4. As working capital is a wider concept of funds, a funds flow statement presents a
more complete picture than cash flow statement.
Procedure for Preparing Cash Flow Statement:
Cash flow statement is prepared with the help of financial statement such as balance
sheet and profit and loss account and some additional information. It starts with the
opening balance of cash and balance at bank. All inflows of cash are added to the
opening balance and the outflows of cash are deducted from the total. Thus the
preparation of cash flow statement involves the determination of inflows of cash and
outflow of cash.
Sources of Cash Inflows:

The following are the main sources of cash inflows:


1.
2.
3.
4.

Cash from operation


Increase in existing liabilities or creation of new liabilities
Reduction in or sale of assets
Non-trading receipts.

1. Cash from Operations


Cash from operations is an important source of cash inflow. It is equal to cash sales
during a particular period minus cash purchase and cash operating expenses. But its
calculation is not so simple as it appears to be. This is so because of certain nonoperating expenses or incomes charged to the income statement. However, cash from
operations can be ascertained by following any one of the three methods such as:
a) From cash sales
b) From net Profit/ Net loss and
c) Cash Operating Profit

a) From cash sales


Cash from operating can be ascertained by deducting cash purchases and cash
operating expenses from cash sales. In other words:
Cash from operating= cash sales-(cash purchase+ cash operating expenses)
Calculation of Cash Sales:
The amount of cash sales is ascertained by deducting the amount of credit sales
from the amount of total sales. The amount of credit sales during a particular
period is equal to the amount of increase in debtors/bills receivable during that
period.
Similarly, the decrease in debtors/bills receivables is to be added to total sales.
But decrease in debtors/ bills receivables may be shown separately as a source
of cash inflow.

Calculation of Cash Purchases:


The amount of cash purchases is found out by deducting the amount of credit
purchases from the amount of total purchases. The amount of credit purchases,
which remains unpaid, is known as creditors/bills payables. Thus the amount of

credit purchases during a particular period is equal to the amount of increase in


creditors/bills payables during the period.
Similarly, the decrease in creditors/bills payables is added to total purchases. But
the decrease in creditors/bills payables may be shown separately as use of cash.

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