Cash Flow analysis
INTRODUCTION – CASH FLOW
A cash flow statement is one of the most important financial statements for a project or business. A
type of financial analysis that compares the timing and amount of cash inflows with the timing and
amount of cash outflows. A firm’s cash flow position can greatly affect its ability to remain in
business. These effects may not be apparent from a cost-benefit analysis. The statement can be as
simple as a one page analysis or may involve several schedules that feed information into a central
statement.
The cash flow statement traces the various sources which bring in cash, such as operations, sale of
current and fixed assets, issuance of share capital and long term borrowings etc. and the
applications which cause outflow of cash, such as, purchase of current and fixed assets, redemption
of debentures, preference shares for cash and so on. This statement is designed for account for the
change in cash
Cash flow statement provides information about the cash receipts and payments of a firm for a
given period. It provides important information that compliments the profit and loss account and
balance sheet. The information about the cashflows of a useful in providing users or financial
statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents
and the needs of the enterprise to utilize these cash flows. The economic decisions that are taken
by users require an evaluation of the ability of an enterprise to generate cash equivalents and the
timing and certainty of their generation. The statement deals with the provision of information
about the historical changes in cash equivalents of an enterprise by means of a cash flow statement,
which classifies cash flows during the period from operation investing and financing activities.
Cash comprises cash on hand and demand deposit with banks.
Cash equivalents are short-term, highly liquid investments that are readily convertible into known
amounts of cash and which are subject to an insignificant risk of changes in value. Examples of
cash equivalents are, treasury bills, commercial paper etc.
The (total) net cash flow of a company over a period (typically a quarter, half year, or a full year) is
equal to the change in cash balance over this period: positive if the cash balance increases (more cash
becomes available), negative if the cash balance decreases.
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,Objectives of Cash Flow Statement
Think of cash as the ingredient that makes the business operate smoothly just as grease is the
ingredient that makes a machine function smoothly. Without adequate cash a business cannot
function because many of the transactions require cash to complete them.
By creating a cash flow budget you can project your sources and applications of funds for the
upcoming time periods. You will identify any cash deficit periods in advance so you can take
corrective actions now to alleviate the deficit. This may involve shifting the timing of certain
transactions. It may also determine when money will be borrowed. If borrowing is involved, it will
also determine the amount of cash that needs to be borrowed.
Periods of excess cash can also be identified. This information can be used to direct excess cash
into interest bearing assets where additional revenue can be generated or to scheduled loan
payments. A Cash Flow statement is prepared to fulfill the following objectives.
1. To determine a project's rate of return or value. The time of cash flows into and out of
projects are used as inputs in financial models such as internal rate of return and net present value.
2. To determine problems with a business's liquidity. Being profitable does not necessarily
mean being liquid. A company can fail because of a shortage of cash even while profitable.
3. Act as an alternative measure of a business's profits: As an alternative measure of a
business's profits when it is believed that accrual accounting concepts do not represent economic
realities. For instance, a company may be notionally profitable but generating little operational
cash (as may be the case for a company that barters its products rather than selling for cash). In
such a case, the company may be deriving additional operating cash by issuing shares or raising
additional debt finance.
4. To evaluate the quality of income generated by accrual accounting : Cash flow can be
used to evaluate the 'quality' of income generated by accrual accounting. When net income is
composed of large non-cash items it is considered low quality.
227
, 5. To evaluate the risks within a financial product e.g., matching cash requirements,
evaluating default risk, re-investment requirements, etc.
Cash Flow is not Profitability
People often mistakenly believe that a cash flow statement will show the profitability of a business
or project. Although closely related, cash flow and profitability are different. A cash flow
statement lists cash inflows and cash outflows while the income statement lists income and
expenses. A cash flow statement shows liquidity while an income statement shows profitability.
Information required for the preparation of a cash flow statement
Comparative Balance Sheets: Balance Sheets at the beginning and at the end of the
accounting period indicate the amount of changes that have taken place in assets, liabilities and
capital.
Profit or Loss Account: The profit and loss account of the current period enables to determine
the amount of cash provided by or used in operations during the accounting period after making
adjustments for non-cash, current assets and currents liabilities.
Additional Data: In addition to the above statements, additional data are collected to determine
how cash has been provided or used e.g. sale or purchase of assets for cash.
Preparation of Cash Flow Statement
Cash Flows Statement can be prepared using International Accounting Standard 7. In India it can
be prepared using the Accounting Standard 3. The cash flows during the period are classified into
3 major categories, they are:-
Cash Flow from Operating Activities
Cash Flow from Investing Activities
Cash Flow from Financing Activities
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INTRODUCTION – CASH FLOW
A cash flow statement is one of the most important financial statements for a project or business. A
type of financial analysis that compares the timing and amount of cash inflows with the timing and
amount of cash outflows. A firm’s cash flow position can greatly affect its ability to remain in
business. These effects may not be apparent from a cost-benefit analysis. The statement can be as
simple as a one page analysis or may involve several schedules that feed information into a central
statement.
The cash flow statement traces the various sources which bring in cash, such as operations, sale of
current and fixed assets, issuance of share capital and long term borrowings etc. and the
applications which cause outflow of cash, such as, purchase of current and fixed assets, redemption
of debentures, preference shares for cash and so on. This statement is designed for account for the
change in cash
Cash flow statement provides information about the cash receipts and payments of a firm for a
given period. It provides important information that compliments the profit and loss account and
balance sheet. The information about the cashflows of a useful in providing users or financial
statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents
and the needs of the enterprise to utilize these cash flows. The economic decisions that are taken
by users require an evaluation of the ability of an enterprise to generate cash equivalents and the
timing and certainty of their generation. The statement deals with the provision of information
about the historical changes in cash equivalents of an enterprise by means of a cash flow statement,
which classifies cash flows during the period from operation investing and financing activities.
Cash comprises cash on hand and demand deposit with banks.
Cash equivalents are short-term, highly liquid investments that are readily convertible into known
amounts of cash and which are subject to an insignificant risk of changes in value. Examples of
cash equivalents are, treasury bills, commercial paper etc.
The (total) net cash flow of a company over a period (typically a quarter, half year, or a full year) is
equal to the change in cash balance over this period: positive if the cash balance increases (more cash
becomes available), negative if the cash balance decreases.
226
,Objectives of Cash Flow Statement
Think of cash as the ingredient that makes the business operate smoothly just as grease is the
ingredient that makes a machine function smoothly. Without adequate cash a business cannot
function because many of the transactions require cash to complete them.
By creating a cash flow budget you can project your sources and applications of funds for the
upcoming time periods. You will identify any cash deficit periods in advance so you can take
corrective actions now to alleviate the deficit. This may involve shifting the timing of certain
transactions. It may also determine when money will be borrowed. If borrowing is involved, it will
also determine the amount of cash that needs to be borrowed.
Periods of excess cash can also be identified. This information can be used to direct excess cash
into interest bearing assets where additional revenue can be generated or to scheduled loan
payments. A Cash Flow statement is prepared to fulfill the following objectives.
1. To determine a project's rate of return or value. The time of cash flows into and out of
projects are used as inputs in financial models such as internal rate of return and net present value.
2. To determine problems with a business's liquidity. Being profitable does not necessarily
mean being liquid. A company can fail because of a shortage of cash even while profitable.
3. Act as an alternative measure of a business's profits: As an alternative measure of a
business's profits when it is believed that accrual accounting concepts do not represent economic
realities. For instance, a company may be notionally profitable but generating little operational
cash (as may be the case for a company that barters its products rather than selling for cash). In
such a case, the company may be deriving additional operating cash by issuing shares or raising
additional debt finance.
4. To evaluate the quality of income generated by accrual accounting : Cash flow can be
used to evaluate the 'quality' of income generated by accrual accounting. When net income is
composed of large non-cash items it is considered low quality.
227
, 5. To evaluate the risks within a financial product e.g., matching cash requirements,
evaluating default risk, re-investment requirements, etc.
Cash Flow is not Profitability
People often mistakenly believe that a cash flow statement will show the profitability of a business
or project. Although closely related, cash flow and profitability are different. A cash flow
statement lists cash inflows and cash outflows while the income statement lists income and
expenses. A cash flow statement shows liquidity while an income statement shows profitability.
Information required for the preparation of a cash flow statement
Comparative Balance Sheets: Balance Sheets at the beginning and at the end of the
accounting period indicate the amount of changes that have taken place in assets, liabilities and
capital.
Profit or Loss Account: The profit and loss account of the current period enables to determine
the amount of cash provided by or used in operations during the accounting period after making
adjustments for non-cash, current assets and currents liabilities.
Additional Data: In addition to the above statements, additional data are collected to determine
how cash has been provided or used e.g. sale or purchase of assets for cash.
Preparation of Cash Flow Statement
Cash Flows Statement can be prepared using International Accounting Standard 7. In India it can
be prepared using the Accounting Standard 3. The cash flows during the period are classified into
3 major categories, they are:-
Cash Flow from Operating Activities
Cash Flow from Investing Activities
Cash Flow from Financing Activities
228
