Cash Flow Statement

MEANING AND OBJECTIVES

Cash plays a very important role in the economic life of a business. A firm needs cash to make payment to its suppliers, to incur day-to-day expenses and to pay salaries, wages, interest and dividends etc. In fact, what blood is to a human body, cash is to a business enterprise. Thus, it is very essential for a business to maintain an adequate balance of cash. For example, a concern operates profitably but it does not have sufficient cash balance to pay dividends, what message does it convey to the shareholders and public in general. Thus, management of cash is very essential.

Cash means, cash in hand and demand deposits with the bank. Cash Flow Statement deals with flow of cash which includes cash equivalents as well as cash. This statement is an additional information to the users of Financial Statements. The statement shows the incoming and outgoing of cash. Cash flows are cash inflows and outflows It is very useful in the evaluation of cash position of a firm

CASH FLOW STATEMENT

The statement of cash flow shows three main categories of cash inflows and cash outflows, namely : operating, investing and financing activities. (a) Operating activities are the principal revenue generating activities of the enterprise. (b) Investing activities include the acquisition and disposal of long-term assets and other investments not included in cash equivalents. (c) Financing activities are activities that result in change in the size and composition of the owners capital (including Preference share capital in the case of a company) and borrowings of the enterprise.

CASH FLOW STATEMENT

INDIRECT METHOD

INDIRECT METHOD
Plus or minus the change in working capital, as follows:
An increase in current assets (excluding cash and cash equivalents) would be shown as a negative figure because cash was spent or converted into other current assets, thereby reducing the cash balance. A decrease in current assets would be shown as a positive figure, because other current assets were converted into cash. An increase in current liabilities (excluding short-term debt which would be reported in the financing activities section) would be shown as a positive figure since more liabilities mean that less cash was spent. A decrease in current liabilities would be shown as a negative figure, because cash was spent in order to reduce liabilities.

Cash Flow Statement Example:

To illustrate a statement of cash flows we will use the first year operations for Tax Consultants Inc. The company started on January 1, 2003, when it issued 60,000 shares of $1 par value common stock for $60,000 cash. The company rented its office space and furniture and equipment, and it performed tax consulting services throughout the first year. The comparative balance sheets at the beginning and at the end of the year 2003 appear as follows.

Balance sheet

Income Statement