Financial Statement- Building Cash Flow Statement

Cash flow statement is a financial statement which reflects the inflow and outflow of cash and cash equivalents from the business during an accounting period. It helps in showing detailed picture of changes in the balance sheet and income statements so incurred due to the entering and leaving a company. It shows how the company manages its cash position by using it effectively in payment of obligations or making investment in different avenues or funding its operating expenditures. Corporates main objective is to maintain a positive cash flow so that it doesn’t fall under the condition to borrow money to keep business growing.

Why it is essential to construct and maintain cash flow statement?

Every business must have sufficient cash to either pay off the debts so risen, invest in the business to generate profitable returns to prevent it to be declared as a bankrupt business thereby.

• It helps in knowing the valuable investors how the business operations are running and helps in measuring whether the company stands on the solid financial footing.

• Where creditors use this information for determining the liquidity of the company and credibility score with respect to payment of debt.

• It serve as a statement which let potential employees and contractors know whether they would be paid with the remuneration.

• It brings clear picture to the Board of Directors which need to ensure that company don’t perform its operations when insolvent.

• It helps in short- term planning as it let us know the availability of liquid cash for upcoming payment obligations.

Cash Flow statement further is divided into three activities:

• Operating activities – These activities record those statements of cash flow which either generates revenue or record the fund so spent on the production of products and services. From the income statement net earnings are recorded which gets reflected in the operating activities. It includes core business activities of manufacturing, distributing, marketing and selling a product or service. It involves funds generated from ongoing and regular business activities rather than long term capital expenses. The information depicted through recording of operational activities help in determining operational efficiency and helps in taking accurate and profitable financial decisions.

There are two methods to record operational activities:

 Direct Method – Under this method all the transactions are recorded on cash basis and all information with respect to inflow and outflow of cash is shown which happens during an accounting period.

 Indirect Method – In this method company first records net income then move in the backward direction to obtain cash figures incurred on operating activities, while all these transactions are recorded on accrual accounting basis when items are recorded only when they are incurred or received.

Operational activities have two categories further:

• Operational Revenue– It refers to the total revenue or income generated through carrying out operational activities. To asses year to year performance comparison is made. It involves:

1. Operating income= Total revenue – Direct cost – Indirect cost

OR

2. Operating income = Gross profit – Operating expenses- Depreciation- Amortization

OR

3. Operating income = Net earnings + Interest expenses + Taxes

• Operating expenses– Expenses of which company want to reduce the burden of which is incurred during its primary or operating business activities. Few of the expenses under it :

1. Accounting fees

2. Advertising and marketing

3. Insurance

4. Legal fees

5. License fees

6. Office supplies

7. Repairs and maintenance

8. Rent

9. Property tax

10. Salaries and wages

11. Utilities and vehicle expenses

• Investing activities – It refers to amount of cash generated or incurred on the investment activities like- purchase of any asset or investment in shares, bonds or other securities.

It basically deals with investment in long term assets or acquiring a certain business or proceeds from marketable securities or collection of loans and insurance proceeds.

Cash flow from Investing activities = Purchase or sale of long term assets + Purchase or sale of business in form of mergers and acquisition + any proceeds or sale generated out of marketable securities.

If negative outcomes are predicted from cash flow of investing activities then may be due to company making investment in research and development activities for its healthy growth.

• Financing activities – Such activities that are undertaken by the firm to meet the economic objectives of the company in order to pay pack their investors. It reflects financial performance of the company, along with managerial ability and competency with prospects of growth and development. Investors and analyst at the time of investment consider these activities as they reflect company’s capital formation and structure.

Items which are seen in the cash inflow of financing activities include:

1. Ordinary shares being issued

2. Issuance of preference shares

3. Bonds and debentures issued

4. Incurring short term obligations by availing loans from banks and other financial institutions.

5. Receiving proceeds from employees on stock option

6. Received cash on issuing hybrid securities.

Items reflected in financial activities of cash outflow includes:

1. Buyback of shares

2. Payment of dividend to the shareholders on their investment made

3. Interest payment risen on debts

4. Repayment of financial obligations

Wrapping up – Cash Flow statement are effectively used to manage one’s outflow of cash and helps in maintaining financial position of the company. The liquidation of the company is the aspect which is reflected through this statement which shows company’s position to pay off its obligation. As positive cash flow is an indicator of growing operations, more investment in assets and securities of the company along with incoming of finance through various options.