What is Cash Flow Statement? | Definition, Components, Pros and Cons

The cash flow statement or statement of cash flows is an essential tool of financial accounting. It is used along with income statement and balance sheet to analyse the financial position of an enterprise. However, it differs from both of them because it does not record the future outgoing and incoming cash under the credit front.

 It encapsulates the amount of cash and cash equivalents that a company receives and spends. The cash that enters as income for the company is called cash inflow, and the cash money that leaves the company as the expense is known as cash outflow.

 Besides that, it evaluates the cash management system of an enterprise. In other words, it assesses how well an enterprise can generate capital to fund its operating costs and pay off its debt obligations.

Components of a Cash Flow Statement

A Cash Flow Statement primarily comprises of the following:

1. Cash from operating activities

This constitutes the first section of the cash flow statement and includes the varied sources of cash generated from a business enterprise’s activities.

These operations may include interest payments, income tax payments, cash received from the sale of products and services, expenditures on production-related goods and services, salaries of employees, rents and other expenses related to company operations.

If the enterprise is an investing company, the cash flow statement may also include equity or debt instruments and sale of loans.

2. Cash from investing activities

This constitutes the second section of the cash flow statement and records the various sources of cash generated from a business’s investments. These sources include investment gains and losses and cash spent on plant, property and equipment.

The accountants look for this section to find out if there is any change in capital expenditures or not. If capital expenditure increases, it implies a negative cash flow and if the cash flow is positive, it means that the company is generating a lot of cash.

Cash from financing activities

This constitutes the last section of a cash flow statement and comprises the varied sources of the company’s cash for financing activities. These activities include payment of dividends to shareholders, repayment of loans and payments for share repurchase.

As the cash flow statement observes the cash generated by a company in the three ways mentioned above, it is considered the most intuitive financial statement. The aggregate of these three sections of the cash flow statement is called the net cash flow. Besides that, an analysis of these three segments allows the investors, lenders and company directors to determine the value of an enterprise’s stocks or the company as a whole.

Advantages of Cash Flow Statement

Some of the significant advantages of a cash flow statement include:

  1. It helps the company to keep track of its liquidity condition.
  2. It gives an idea of a company’s capacity to pay off its bills.
  3. It enables a company to prepare its future estimates based on its cash inflows and cash outflows.
  4. It helps a company get loans and attract investments as the lenders and investors can evaluate the company’s stocks from its components.
  5. A proper cash flow statement allows judicious management of cash.

Disadvantages of Cash Flow Statement

Despite being an intuitive financial statement, the statement of cash flows is not without its share of limitations:

  1. The cash flow statement does not reflect a company’s net income as it records only cash transactions and not the non-cash items.
  2. The financial status of a company cannot be assessed by the cash flow statement alone. It needs to be supported by the income statement and balance sheet.
  3. The preparation of a cash flow statement is based on historical or book value. Consequently, it does not give an estimation of future cash flows.

References

  1. https://go.gale.com/ps/i.do?id=GALE%7CA19369688&sid=googleScholar&v=2.1&it=r&linkaccess=abs&issn=00076813&p=AONE&sw=w
  2. https://www.emerald.com/insight/content/doi/10.1108/03074351311323455/full/html
x
2D vs 3D