Understand how the cash flow statement works and assess your company’s financial health!
A cash flow statement is one of the three mandatory financial reports. This includes the income statement and balance sheet. These are reports which every organisation is expected to file at regular intervals. It helps companies track cash inflows and outflows and performance. This is in terms of their ongoing operations, business activities, and external investments.
Before investing in a company's stock, check its cash flow statement. This could help you understand its financial standing. It shows how the organisation uses the money earned from operations and manages debt.
Companies offering stocks to the public must file these reports with SEBI. The statement of cash flows involves cash accounting. It records payment receipts and expenses as and when they are received and paid.
A large number of companies make profits yet fail to manage their cash flows. This is where the cash flow statement makes a major difference. This statement gives an insight into the kind of transactions a company makes.
This statement aids in evaluating a firm's ability to generate cash and meet expenses. A positive cash flow shows that a company is financially stable. But a negative cash flow indicates potential challenges that a firm may be going through.
To compute cash flow, the net income needs to undergo a few adjustments. The firm must add or subtract the differences in its revenue, credit transactions, and expenses.
There are two ways to calculate cash flow:
1. Direct Cash Flow Method
This means listing all payments and cash receipts during the company’s reporting period.
2. Indirect Cash Flow Method
This option starts with net income. Then, the amount is deducted or added for changes in non-cash transactions.
Every business requires adequate cash for the smooth functioning of its operations. A cash flow statement plays a vital role in helping it achieve success in the following ways:
1. Provides information About Outflows
It helps analyse a company’s ability to make payments to its creditors. The statement also provides a detailed record of all transactions.
2. Maintains Cash Balance Record
It provides a clearer picture of whether there is a lack of cash or if there are additional unused funds. This may help the company utilise them. But, if there is a lack of funds, the organisation can plan strategies to borrow cash.
3. Focuses on Cash Generation
Every company aims to make profits through its business ventures. This may be specifically through the generation of cash. Making the right decision is crucial to maximise its growth.
4. Helps in Short-term Planning
It's a useful report that could help with a company's short-term planning. This statement may help it maintain enough liquidity to meet different obligations. Such advance planning may help it make timely payments. The past data could be used to project the cash inflows and outflows.
The statement may sometimes show a negative cash flow, raising concern among investors. But this may not mean that the company is on the brink of bankruptcy.
An organisation at times may decide to expand its reach for future gains. As a result, it might display poor cash flow in the present. Analyse changes in the cash flow from one account period to another. It may help you understand its performance.
Frequently Asked Questions
Why is a cash flow statement required?
The cash flow statement provides information about the flow of cash in and out of the business. This helps investors get an idea of the company’s transactions and profitability.
What does a cash flow statement format include?
The cash flow statement is divided into three main categories. These are cash flows from operations, investing, and financing.
How to calculate cash flow?
There are a few methods to compute a company’s cash flow. One of the formulas for calculating it is as follows:
Free Cash Flow = Net Income + Depreciation and Amortisation – Change in Working Capital - Capital Expenditure
What is the difference between cash flow and net income?
The profit earned by a company during a particular period is called net income. Cash flow is the money that moves in and out of a company due to its business activities.
What is the difference between a cash flow statement and an income statement?
The cash flow statement helps a business keep track of all the cash inflows and outflows. This is for a specific accounting period. An income statement records transactions related to expenses, revenues, losses, and gains. during a given accounting period.
What is the difference between a cash flow statement and a balance sheet?
A cash flow statement gives an account of all the money that flows in and out of a company. This may be due to its business activities. A balance sheet contains information regarding the organisation’s assets and liabilities. This also includes the amount invested by shareholders registered under the shareholders’ equity.
What are the factors that affect cash flow?
There are few of the factors that affect cash flow. These include credit terms, inventory, accounts receivable, credit policy, and accounts payable.
What is negative cash flow?
When a company shows more outgoing funds than incoming funds, it is said to have a negative cash flow. A company could tackle this through external investments and financing.
How to prepare a cash flow statement?
Gather financial statements, identify the reporting period, and choose the calculation method. Then, calculate cash flow from operating, investing, and financing activities. Determine the final balance, and reconcile it with the beginning cash balance.
What are the methods for calculating cash flow statements?
A company can choose the direct or indirect method to prepare the statements.
What does the direct method of calculating cash flow statements mean?
Under the direct method, the company considers the direct cash inflows and outflows from their operations.
What is a cash flow statement?
This is a crucial financial statement providing valuable insights into an organisation’s financial flexibility, liquidity, and solvency.
What are the two methods for preparing a cash flow statement?
The Direct Method reports major cash receipts and payments, like those from customers and to suppliers. The Indirect Method adjusts net income for non-cash items, such as depreciation and changes in working capital, to calculate net cash flow.
What is cash flow in finance?
Cash flow refers to the net movement of cash in and out of a business. Positive cash flow means more money is coming in than going out, indicating financial stability. Negative cash flow means more money is going out than coming in, which could signal financial trouble.
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