Sunday, 4 January 2015

Cash Flow Statement and its importance

What is Cash Flow?
By Cash Flow  we mean the flow of cash in your hands or at your business. Cash always flows either into your purse from others or out of your purse to others.

Any business activity involves cash transaction- cash and cheque both are considered as cash for this purpose. Either cash comes to you or it goes out from you. This process of incoming and outgoing of cash is known as Cash Flow. Cash continuously flows either into your hands/business or out of your hands/business.

What is Cash Flow Statement?
A cash flow statement is a statement showing the details of inflows and outflows of cash in money value in a format. It depicts the funds generated and spent during a period of the business.

The need for Cash Flow Statement
The flow of cash needs to be tracked to have a better management of the funds of the business. You need to know where from your cash comes and how you are spending it so as to bifurcate and identify your spending habits. Once you can know the full details of your spending, you will be in a better position to manage your funds efficiently. For this purpose, you require the cash flow statements.

Types of Cash Flow Statements
Cash Flow statements are prepared in two methods

  • Direct method - this method takes the actual income and expenses received or paid during the period. These items are directly incorporated in this statement headwise. It can contain advance payments and advance receipts also. This will give you a real picture of increase or decrease in your cash balance and bank balances.
  • Indirect method - In this method, you will start from the net increase or decrease as found from your records and back calculate the expenses and incomes during that period to explain the net figure.

Further, a cash flow is nowadays prepared in three different stages in modern finance system.

  • Cash Flow from Operating Activities
  • Cash flow from Investing Activities
  • Cash flow from Financing Activities

How to prepare a Cash Flow Statement?
Here, I am going to explain the direct method of Cash Flow Statement.

A cash flow statement is prepared by keeping record of all payments and receipts during the period. All transactions are to be segregated into suitable account heads that you may consider fit for you or you can maintain the same account heads as in a trial balance or profit & loss account.
  • In this Cash Flow Statement, you will record income received on one side and expenses incurred on the other side just like a Trial Balance format. 
  • But the figures taken in this cash flow are actual receipts and actual payments during that period. 
  • You should have actually received the actual cash or cheque or draft during that period for showing it in your statement. 
  • Similarly, you should take only actual cash or bank payments made on the expenditure side and no accrued expenses or unpaid expenses should be taken into consideration for this statement. 
  • All figures that actually affect your cash or bank balance should be taken in this statement. No other figures should be included to get the correct picture.

The statement may be prepared either weekly, monthly or on annual basis. Sometimes, it is prepared daily also to track daily expenditure. You can have it prepared in all the four formats for a better understanding and control of your business.

The figures are taken in actual incurred basis. So the statements of Cash Flow and Profit & Loss does not tally for any period because profit & loss statement includes total expenditure whether it is paid or not.

The figures in the cash flow show you all the income you received into your cash box or bank account during a particular period under study and all the payments made by you during the same period whether it is by cash or bank. So, the net effect of these receipts and payments will give you the position of whether you are in plus or minus.

Benefits of Cash Flow Statement
  • Cash Flow statement gives you a picture of your receipts and expenditure during a period. It shows the spending nature of your business.
  • With the help of cash flow statement, you are able to locate where you are spending more and where it is too low and, thereby, you can adjust and control your activities suitably.
  • You can plan your project expansions and business growth with the help of this statement.
  • Sometimes, banks and financial institutions may require cash flow statements to judge your capability of repayments in case of applying for loans.

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