What is Cash Flow Statement? Meaning, Definition & Importance

A cash flow statement explains the inflows and outflows of cash and cash equivalents during a specified period of time. Such inflows and outflows are classified into operating investing and financing activities during a particular period of time.

Cash flow statement identifies the impact of different business transactions on cash and its equivalents and considers the receipts and payments of cash. A cash flow statement is used to identify all the factors which lead to changes in the cash position of a business enterprise between the opening and closing dates of balance sheets. Usually, cash flow statement is referred to as a “postmortem exercise” or a method of historical financial analysis. A cash budget is a method used for financial forecasting.

The main aim of preparing cash budget is to determine the estimated excess of receipts over payments or vice-versa, in order to make plans regarding the investment of excess of cash or to make arrangements for the future deficits of cash.

Advantages of Cash Flow Statement

Cash flow statement plays an important role in financial management. It is mainly used for short-term planning and acts as an important tool of financial analysis. The main advantages of cash flow statement are as follows,

1. As cash flow statement is prepared on cash basis of accounting, it is useful in ascertaining the cash position of a firm.
2. Analysis can be done by comparing the historical cash flows with the projected cash flows to identify the variations and deficiency in the performance so that firm can take effective measures to avoid it.
3. Cash flow statement is prepared in a standard format prescribed by AS-3 (Revised) which can be effectively used for making comparisons with other firms.
4. In order to identify whether the firm’s liquidity position is improving or deteriorating a series of intra-film and interfirm cash flow statements are prepared for specific period of time.
5. Cash flow statement is an effective tool which helps in planning the repayment of loans, replacement fixed assets and it is also useful in capital budgeting decisions.
6. As cash flow statement takes very less time to analyze the ability of firm to meet its obligations, it is more suitable than funds flow statement is conducting short-tern financial analysis.
7. Cash flow statement reveals all the information relating to operating investing and financing activities of the firm whereas, finds flow statement does not reveal information about these activities separately.
8. It helps in identifying the reasons which leads to poor cash position inspite of the generation of sufficient profits by a firm. It is mainly emphasizing on the different application of cash made by the firm.
9. An estimated cash flow statement is prepared for forecasting the future cash position of a concern to help the firm in effectively planning and organizing its financial operations.
10. A projected cash flow statement helps in identifying the inflows and outflows of cash so that firm can plan for its future requirements of cash.

Disadvantages of Cash Flow Statement

1. Apart from its advantages it is also associated with several limitations such as.
2. Cash flow statement is prepared on cash basis of accounting which makes the firm to neglect the accrual basis of accounting.
3. As working capital is a wider concept of funds than cash. funds flow statement represents a complete financial picture of a firm which is not possible through time cash flow statement.
4. A cash flow statement is not a replacement of an income statement, it is referred to as complementary statement to it.
5. Usually, a comparative study of cash flow statement gives fallacious (false) results.
6. A cash flow statement is not appropriate in determining the profitability of a firm because all the noncash items are not included while evaluating the cash flows obtained from operating activities.
7. A cash flow statement cannot be replaced with funds flow statement which explains about the reasons of increase or decrease in working capital.

Features of Cash Flow Statement

The important features of cash flow statement are as follows,

1. Cash flow statement acts as an important device which is being used in the financial planning.
2. Cash flow statement basically relies upon the past information i.e., the actual cash receipts and cash payments for a specified time period.
3. Cash flows comprise of both cash inflows and cash outflows and the information derived out of the Cash flow statement is useful in preparing the cash budget.
4. Cash flow statement is prepared yearly once as it is drawn from income statement and balance sheet of two successive years.
5. It is prepared and introduced by the listing companies.
6. Cash flow statement helps/assists in evaluating the ability of an enterprise to achieve its future obligations with the use of cash inflows out of the future operations.
7. It is necessary to understand the movement of cash flows in a precise manner with an aim to avoid short-comings of the financial liquidity of an enterprise. It is well-known that cash is a blood of any business for which it is essential to take proper actions to make optimum utilization of it.
8. Soon after the issues and major areas are recognized, Cash flow statement enables in taking future decisions.
9. Cash flow statement helps in evaluating the company’s ability to pay taxes, dividends, bonds, interest on bonds and debentures, obligations to employees and suppliers and so on.
10. Cash flow statement assists in evaluating the main reasons of difference/variation between net profit and net cash flow out of the operations.
11. It helps in evaluating the long-term bookings and its repayment, capital transactions and other factors which effects the liquidity of an enterprise.
12. Financial strength of the company from both the views i.e., cash and non-cash investing and financing transactions which takes place during the accounting period is also being evaluated with the help of Cash flow statement.
13. Cash flow statement also helps in evaluating the present and future status of cash with which the management can easily plan for future such as: from the desired cash for what purposes the fund can be utilized and so on.
14. Cash flow statement assists in presenting out the cash and non-cash effects of investing and financing activities during particular accounting period of time.
15. In case of any differences between the expected cash flows and the actual cash flows, Cash flow statement assists the management in taking appropriate decisions.
16. Cash flow statement is also helpful to the management both internally as well as to the investor and creditors extremely as it helps in evaluating the capability of an enterprise to manage cash flows in paying their obligations (or) to pay interests (or) dividends.