The facts contained in the balance sheet and the profit and loss statement is connected by the bridge that is the statement of cash flows. By recording the flow of cash and cash equivalents into and out of the company the statement of cash flow is a good indicator of a company’s health. Thus, the purpose of the statement of cash flow is to reflect in record form the cash balances reflected in the balance sheet.
The statement of cash flow has three main sections and each section tells us a unique thing about the company. The operating section tells us how the company is generating and using cash to support its day to day activities. Specifically, it gives information about the payments for the sales of loans, debt or equity instruments in a trading portfolio, the interest payment, tax payment, payments to suppliers for goods and services, dividends on equity securities, interest received on loans, receipts received on loans and receipts from sale of goods and services.
Also the cash flow statement helps assess the ability of the entity to pay its bills and meet its obligations. The investing section tells us how a company is using its cash to grow long-term. If you see a lot of investments outflow, that means that the company is investing in capital projects that will sustain its earnings in the long-term. It gives information about the investing activities that are used with operating activities. The cash that goes into the investing activity of the firm is disclose by the cash flow statement.
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This includes loans made to suppliers, assets like and, purchase. Financing sections tells us the equity and debt situation of the company or how a firm is raising money to support its short-term and long-term goals. In detail the cash in financing activities provides information about the proceeds from issuing shares, from issuing short term or long term debt, from capital leases, repayment of debt principal, payments made for repurchase of shares and payments of dividends. Fundamentally, the purpose of the cash flow statement is to inform about the past sources of cash to forecast the bility of the entity's ability to generate a positive cash flow in the future. The cash flow statement provides information from where the entity's cash is coming from. Is it coming from operations mainly or it is coming from other sources. The cash flow statement also provides information about the effect of investment and financing on the operations of the business. There are three parts of the cash statement namely cash from operating activities, investing activities and financing activities.
The cash flow statement gives us the opening balance of cash, the amount of cash received during the operating period, the amounts paid during the period, the net increase or decrease in cash for the period and the final cash flow balance. When assessing the financial strength of a business it is important to know the cash flow statement because it gives an idea if the firm will be able to pay salaries and other immediate expenses. The cash flow statement also gives information if the firm will be able to repay its creditor. The cash flow statement also informs the lender or potential lenders if the company is financially sound.
The contractors and future employees can assess if the cash flows of the company will be able to pay them salaries. While assessing the financial strength of a business it is necessary to know the time, amount and chances of future cash flows, the cash flow statement provides this information. For assessing the financial strength of a firm it is important to compare the operating performance of different companies, the cash flow statement allows this comparison. Further, it is important to ass the changes in assets, liabilities and equity. The cash flow statement provides such an opportunity.
Most importantly, it is necessary to know the liquidity and cash in hand of a firm. Essentially the cash flow statement helps assess the financial position of the company by indicating to an investor how much cash flowed into and out of the company over a period of time and in addition it helps reconcile the income statement with the balance sheet. The accounting assumptions that are used for preparing the income statement and the balance sheet are compared with the hard cash earned. No assumptions are made in the preparation of the cash flow statement, and there are not estimations in the cash flow statement.
Finally, by closing observing the statement of cash flow, one can determine the solvency of a company and how liquid it is. Having excess cash is an indicator that a company is very liquid and will likely return money to the stakeholders and is likely to be in sound financial condition. If a company is struggling then it will have very little cash. It will struggle to meet its debt obligations and may go into bankruptcy as well.
- The accounting process. (2010). Retrieved on December 12, 2012 from http://www. netmba. com/accounting/fin/process
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