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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.
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: