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Preparation of a Cash Flow Statement Essay Sample

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  • Pages: 3
  • Word count: 578
  • Rewriting Possibility: 99% (excellent)
  • Category: finance

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Introduction of TOPIC

In preparing a statement of cash flows, the term cash is broadly defined to include both cash and cash equivalents. Cash comprises cash on hand and demand deposit with banks. Cash equivalents consist of short term, highly liquid investments such as treasury bills, commercial paper, and money market funds. Such investments are made solely for the purpose of generating a return on funds that are temporary idle.

Instead of simply holding cash, most companies invest their excess cash reserves in these types of interest bearing assets that can be easily converted into cash. These short term liquid assets are usually included in marketable securities on the balance sheet. Since such assets are equivalent to cash, they are included with cash in preparing a statement of cash flows. Cash flows are inflows and outflows of cash and cash equivalents. It means the movement of cash into the organization and movement of cash out of the organization. The difference between the cash inflow and outflow is known as net cash flow which can be either net cash inflow or net cash outflow.

Purpose of cash flow statement:
The basic purpose of a statement of cash flows is to provide information about

the cash receipts and cash payments of a business entity during the accounting period. The term cash

flows include both cash receipts and cash payments. In addition, the statement is intended to provide information about the investing and financing activities of the company during the period. A statement of cash flows assists investors, creditors and others in assessing such factors as:

* The company’s ability to generate positive cash flows in future period; * The company’s ability to meet its obligations and to pay the dividends; * The company’s need for external financing;

* Reasons for differences between the amount of net income and the related net cash flows from operating activities; * Both the cash and non cash aspects of the company’s investment and financing transactions for the period; * Causes of the change in the amount of cash equivalents between the beginning and the end of the accounting period.

Stated simply, a statement of cash flows helps users of financial statements evaluate a company’s ability to have sufficient cash – both on a short run and on a long run basis. For this reason, the statement of cash flows is useful to virtually everyone interested in the company’s financial health; short and long time creditors, investors, management and both current and prospective competitors.

Limitations:
Cash flow statement is a useful tool of financial analysis. However, it suffers from some limitations, which are as follows: * A cash flow statement only reveals the inflow and outflow of cash. The balance disclosed by the statement may not depict the true liquid position. There are controversies over a number of items like check, stamps, postal orders etc. to be included in cash. * A cash flow statement cannot be equated with the income statement. An income statement takes into account both cash and non cash items. Hence, cash fund does not mean net income of the business. * Working capital being a wider concept of funds, a funds flows statement presents a more complex picture than cash flow statement.

Reference:

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