Cash Flow is the movement of cash and its equivalents. It includes the inflow and the outflow of cash during a particular period. All transactions which lead to increase in cash and cash equivalents are classified as inflows of cash and all those transactions which lead to decrease in cash and cash equivalents are classified as outflows of cash. Cashflow statement, therefore, is a statement that shows flow of cash and cash equivalents during period.
OBJECTIVE OF CASH FLOW STATEMENTS:
Cash Flow statement is prepared with an objective to high light the sources and uses of cash and cash equivalents for a period. Cash flow statement is classified under operating activities and financing activities. It shows the net increase or net decrease of cash and cash equivalents under each activity.
USES OF CASH FLOW SATEMENT:
- Short Term Planning. Cash Flow Statement gives information regarding sources and application of cash and cash equivalents for a specific period so that it becomes easier to plan investment, operating and financial needs of an enterprise.
- Cash Flow helps to understand Liquidity and Solvency. Solvency is the ability of the business to pay its current liabilities. Quartely or monthly cash flow statements help to as certain liquidity in a better way. Financial institutions, like banks, mostly prefer Cash Flow statement to analyse liquidity.
- Efficient cash Management. Cash Flow Statement provides information relating to surplus or deficit of cash. An enterprise, therefore, can decide about the short term investment of the surplus and can arrange short term credit in case of deficit.
- Prediction of sickness. Continuous cash deficit is an indication of sickness.
- Comparative study. A Comparison of the cash flow for the previous year with the budgeted figures of the same year will indicate as to what extent the cash resources of the business were generated and applied according to the plan. It is, therefore useful for the management to prepare cash budget.
- Reasons for Cash position. Cash Flow statement explains the reasons for lower and higher cash balance with the firm. Sometimes, a lower cash balance is found inspite of heavy profits or a higher cash balance is found inspitte of lower profits.
LIMITATIONS OF CASH FLOW STATEMENT
Through the cashflow Statement is a very useful tool of financial analysis, yet it has its own limitations which must be kept in mind at the time of its use. These limitations are:
- Non-Cash Transactions are ignored.
- Not a Substitute for Income Statementt.
- Not a test of Total Financial Position.
- Historical in Nature.