Understanding Cash Flow Statements : Importance and Relevance

Cash Flow Statement is one of the key financial tools to provide assistance in a company’s analysis. It is among the three major financial statements of a company. The Cash Flow Statement keeps an account of the cash and cash equivalents a company has. It also lets us know whether a company is using the same well to fulfil the debt obligations or not. The cash flow statement consists of three major elements. They are operating activities, financing activities and investing activities. Also there are two methods in calculating the cash flow of a company – Direct Method and Indirect Method. 

Utility of Cash Flow Statement 

The investments in a company by outsiders is considered after analysing the ahs flow statement. The cash flow statement consists of the daily operations of the firm and its capacity to pay off the debts that iot has. Also the creditors of the company analyse the cash flow statement to extend or give a credit line to the firm. On the other hand the investors also check the CFS to make an informed investment decision. UIf the company has cash reserves it can further expand its business and also meet any extraordinary expenses or crisis in the future with the same. Along With this the investors get a know how about the financial base of the company which increases their confidence in the company.

Structure

The structure of the cash flow statement is divided into three major activities. The operating activities, financing activities and investing activities. In some cases it also includes non cash activities.

The operating activities include any revenue generation from the daily business of the firm. It also includes the daily business expenses to run the routine activities. Some forms of the same are Sales receipts, Income tax payments, Interest Payments, Rent payments, Salaries, Payments to creditors etc. Thus this includes the money from daily business activities based on the nature of the business. 

The financing activities include money activities on part of the banks, investors etc. This includes dividend payments, Repayment of loans, stock repurchase etc. The company mentions a cash in activity in case the money comes in like raising money from investors for future projects.On the other hand there is cash out when the dividend payments are made. Only one exception to this financing activity is the interest payment. Although it is a cash out activity it is recorded as an operational activity and not a financing activity.

The investing activities include money used from any investments made by the company. This includes purchase and sale of assets, payments for Mergers and Acquisitions etc.

Methodology for Calculating Cash Flow

There are two methods of calculating the cash flow of a company. This includes the direct and indirect method. Direct method is when all the expenses and incomes are added up. The cash in and cash out of all the business activities are calculated together by the opening and closing balances of the businesses. This is more relevant for the small businesses as they have less amount of cash flow to handle. 

In the indirect method the company’s cash flow is based on the net income generated by summing up the differences from non-cash transactions. This means that the difference in amount from the change in valuation of assets or amount of liabilities from one period of time to another is adjusted. Hence a net figure is generated.

Limitations

The cash flow statement directly includes the figures generated from the calculation of numbers. It ignores the intangible benefit of the long run. IN other words if a company has a negative cash flow but it is on account of the expansion that it has undertaken in the recent past and will render better results for the company in future. This cannot be identified by just looking at the cash flow statements, Hence a cash flow statement definitely adds up value to the decision making power of investors and creditors but it has its own limitations as well.

Other Information

The cash flow statement gives the investors and creditors a clear outlook of how the company’s performance is and will it be able to become profitable in future or not. Whether the company has a solid financing capability or will it become bankrupt based on the line of expenses against the reserves and income of the firm. Hence all such things can be analysed by just viewing at the figures laid out in the cash flow statement.

Alongside cash flow statements the inventors also look up at the income statement and balance sheet to come to a decision about their investments. The CFS is a key indicator for the company’s performance and also a guide for the profitability, strength and long term future outlook for the firm. It states the company’s ability to tackle any uncertain situations i future and also tells whether the company can afford expansion plans or not.

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