Posted: November 27th, 2013
Cash Flow Statement
Cash Flow Statement
Components Needed in Cash flow Statements
In a simplified explanation, a cash flow statement analyzes a company’s flow of money in a fixed period. It explains the cash and cash equivalent changes during that given period. The three main components of a cash flow required by the International Accounting Standard 7 are operating activities, investing activities and financing activities (IFRS, 2011). When computing these components up, one gets a decrease or an increase in cash flows.
The operating activities identify the in and out cash activities that take place so that a business can take place. The cash from operating activities show the money received from sales. This money includes interest from loans, receipts from sold goods and payments of tax. This component of the statement is the most significant. This is because one can assess a business’s ability to turn profit based on its model at a particular moment in time (Ord, 2011). If a business is having difficulties making profit from its activities, chances are that the business will have financial difficulties and make investments in software or hardware with no evidence of success.
The operating activities can be represented using the indirect or the direct method. However, the bottom line is similar in both cases although the two formats start at separate points. The direct method exposes the amount of cash that was received from sales and the amount of cash that was used in inventory and other operating expenses. The indirect method begins with the net income as a summary of the business’s cash transactions for operating expenses. In addition, the net income is inclusive of non-cash transactions. For this reason, these non-cash transactions must be eliminated from this sum in order to come up with an accurate figure operating activities’ cash flow (Ord, 2011).
Investing activities include money spent in purchasing long term assets needed to produce or sell services and goods. These activities include securities or stocks’ purchasing. The most important thing to know about this part of the statement is that the money posted here should be money handed over in cash and not the credit part of the purchase. For example, if a firm was to purchase securities worth $10 million, but only handed over cash amounting to $5 million and the other $5 million in financing, cash flow statement will only reflect $5 million.
Financing activities include cash relating to shareholders and investors. When a business raises money from long-term loans, stock or bonds, this is considered as an “income” and is recorded in the financing activities part of the cash flow. When a business pays out dividends to the shareholders and investors or bondholders’ interest, it is considered as an outflow of cash and is it also recorded here (Ord, 2011).
There are exceptions to the cash flow statements. Marketable securities, which are short-term, are taken to be long-term and are therefore recorded as investing activities. Short-term debts are also taken to be long term ones thus recorded as financing activities. Dividends and interest payments are recorded in different entries in different parts of the statement even though they are both outflows of cash to outsiders. The dividends’ payments are recorded as financing activities and the interest payments are recorded as operating activities.
Benefits of Cash Flow Analysis
For the newly founded businesses, the cash flow statement helps the owners to follow up with the cash flow thus knowing whether the business is running short of cash or not. Business owners can identify a business’ ability to turn profit, based on its model at a particular moment in time by analyzing the operating activities (Klammer & AICPA, 2003). In general, the cash flow is not only used by the newly founded companies, but it is also of great importance to the whole business. Every business needs to assess its cash flow position.
The cash flow statement is needed by the management when making its decision. It is important for the management to understand the inflow and outflow of cash in a business in order to assess how to minimize or increase the flow if the turnover places the business at a risk.
The cash flow is of great significance to the investors. Investors looking at a cash flow statement can be able to assess whether a company is financially sound. There are businesses that record an increase in cash yet they are making losses while others record a decrease in cash or no cash at all yet they are making profits (Klammer & AICPA, 2003). It is significant that the investors are aware of correctly analyzing this statement as it can be complicating and confusing if handled by an inexperienced individual.
The cash flow statement is also significant to the management when making the short-term plans and decisions (Wilkins & Louder, 2000). It is through analyzing the cash flow statement that the managers know whether the business has enough money to pay its employees, recruit new employees and purchase new assets amongst other cash outflow related activities.
It is necessary for the company to keep track of the inflow and outflow of cash for auditing purposes and the annual report. Cash flow records for the particular periods make the annual compiling of financial statements run smoothly and be of significance. These statements are most effective when they are compiled quarterly or bi-annually.
The statement analysis is also significant to outside bodies such as the government, external auditors or other legally allowed bodies. They may require this statement if they want to analyze the business as a whole in order to categorize it or sanction it. It is therefore significant that this statement portrays a true reflection of the actual happenings. Misrepresentation of records may put the business in trouble with the law.
Problems Arising if a Cash Flow analysis is not Conducted
Failure to monitor the cash flow is disastrous thing to any business. It is significant for the management to make sure that they know the inflow and outflow of cash so that the business might be in a position of carrying out some activities (Shadunsky, 2011). These activities include paying creditors, paying employees, knowing whether it is in a position of making new investments amongst other activities. If such activities are not carried out, the business may end up in many debts.
A business may find itself in a financial distress if it does monitor the cash flow. It can be because of having very little cash to pay off the debts or too much cash that is not invested. In worse case scenario, lack of cash may lead to a business’s bankruptcy, which in turn may lead to business liquidation (Shadunsky, 2011).
Cash is part of capital because it makes up the working capital. Some occurrences take place when the management fails to keep track of the capital. The business may make sales that are too high and therefore attract large accounts receivable portfolio (Shadunksy, 2011). Lack of monitoring the capital may lead the company in having too little cash to pay the short-term debts. This leads to conflicts or even company takeovers by the lenders.
Failing to monitor the cash flow causes the management to notice some challenges that can be easily corrected; they develop to become big challenges leading to bigger problems. For example, if the business notes that the in-flow of cash from debtors is not satisfactory. They can stop selling goods on credit at the early stages before the accounts receivables build up to become unmanageable.
International Financial Reporting Standards, (2011). IAS 7 Statement of Cash Flows. Deloittte Global Services. Retrieved From http://www.iasplus.com/standard/ias07.htm
Klammer, T. P., & American Institute of Certified Public Accountants. (2003). Cash flow statements: Preparation, presentation, and use. Lewisville, TX: American Institute of Certified Public Accountants.
Ord, T., (2011). Cash Flow Statement Example and Components. Retrieved From http://www.mysmp.com/fundamental-analysis/cash-flow-statement.html
Shadunsky, A. (2011). What Problems Could Arise If a Cash Flow Analysis Is Not Conducted? eHow Money. Retrieved from http://www.ehow.com/info_11400176_problems-could-arise-cash-flow-analysis-not-conducted.html
Wilkins, M. S., & Loudder, M. L. (January 01, 2000). Articulation in cash flow statements: a resource for financial accounting courses. Journal of Accounting Education, 18, 2, 115-126.
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