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The Cash Flow Statement

The cash flow statement is a financial statement that summarizes all cash and bank transactions of a company during a specific period. It's a crucial statement required by accounting regulations in many countries, including India.

1. Categorizing Cash Flows

Cash flows are broadly categorized into three activities:

  1. Operating Activities: These relate to the core business operations. They include:

    • Cash Inflows: Cash sales, collections from credit customers.
    • Cash Outflows: Payments to suppliers, employees, utilities, rent, advertising, selling and distribution expenses, and taxes.
    • Net Cash Flow from Operating Activities: The sum of all operating cash inflows and outflows. A profitable company typically has a positive cash flow from operations. Format:-

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  2. Investing Activities: These relate to the acquisition and disposal of long-term assets. They include:

    • Cash Outflows: Purchase of fixed assets (machinery, equipment, land, buildings, intangible assets).
    • Cash Inflows: Sale of used fixed assets, interest income, dividend income.
    • Net Cash Flow from Investing Activities: The sum of all investing cash inflows and outflows. Growing companies often have negative cash flow from investing activities due to investments in new assets. Format:-

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  1. Financing Activities: These relate to how the company raises capital. They include:
    • Cash Inflows: Issuance of equity shares, borrowing loans.
    • Cash Outflows: Repayment of loans, repurchase of company shares (treasury stock), interest payments, dividend payments.
    • Net Cash Flow from Financing Activities: The sum of all financing cash inflows and outflows. Interest and dividend payments are included here because they represent returns to capital providers (lenders and shareholders). Format:-

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2. Calculating Net Cash Flow and Ending Cash Balance

  • Net Cash Flow for the Period: The sum of net cash flows from operating, investing, and financing activities.
  • Ending Cash Balance: Opening Cash Balance + Net Cash Flow for the Period.
  • Verification: The ending cash balance derived from the cash flow statement should match the ending cash balance shown on the bank statement and the balance sheet.

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3. Methods of Preparing the Cash Flow Statement

There are two methods for preparing the cash flow statement:

  1. Direct Method: This method directly shows cash inflows and outflows from each operating activity. It requires detailed information from the cash and bank accounts. This is the method described in the initial text.

  2. Indirect Method: This method starts with net income from the income statement and adjusts it for non-cash items and changes in working capital accounts to arrive at the net cash flow from operating activities. It uses information from both the income statement and the balance sheet.

Conclusion

The cash flow statement provides valuable insights into a company's cash position. It shows how the company generates and uses cash, which is crucial for assessing its liquidity, solvency, and overall financial health. The direct method provides a clear picture of cash movements, while the indirect method reconciles net income to net cash flow from operations.