Definition: Cash Flow Statement refers to an Analytical Reconciliation Statement, which shows the changes in the position of cash and cash equivalents between two periods. In addition to this, it emphasizes the reasons for such movement of cash. Cash equivalents are those investments which are short term as well as highly liquid in nature, that can be easily transformed into cash.
It is prepared in accordance with the provisions of International Accounting Standard (IAS) – 7 and in India, as per Accounting Standard – 3 (Revised).
From a financial point of view, the cash flow statement is an important part of the financial statement, along with the Balance Sheet and Income Statement. It is concerned with the inflow and outflow of cash to/from the business. It specifies the sources of cash to the firm, from various activities and the uses of cash during a time interval.
Classification of Cash Flow Statement By Activity
The classification of cash flows, allows the users to evaluate the effect of such activities on the company’s financial position. The link between these activities can also be assessed with the help of the information provided by the statement.
- Operating Activities: These activities take into consideration, the firm’s core revenue-producing activities. It includes the production or purchase and sale of goods and services, receipt of royalty, fee, commission, etc., payment of insurance premium and receipt of claims, payment to suppliers, payment to or on behalf of employees and so on.
The reporting of cash flow from operating activities can be done in two ways, i.e. by using a direct method or indirect method. Both methods are used for converting net profit into net cash flows.
- Investing Activities: The activities which involve the procurement and disposal of long-term fixed assets, buying and selling of investments such as shares, warrants, and debentures, etc. and disbursement and collection of advances and loans are investing activities.
- Financing Activities: The activities that can change the size and composition of the shareholder’s equity and borrowed funds of the firm are financing activities. Such activities include payment/receipt of interest and dividend, raising funds from lenders and shareholders, repayment of loans and redemption preference share capital.
These three sections present the net change in the balance of cash in hand and at the bank of the firm. It is an important tool for short term analysis especially, its ability to pay bills. It is a summary, which helps the users of financial statement to know the firm’s performance in generation and utilization of cash. It also helps managers in budgeting and business planning.