It is necessary for any business organisation to maintain adequate level of cash to operate smoothly. Cash flow occurs when net effect of a transaction either increases the cash or cash equivalent or decreases the cash or cash equivalent. If there is an increase in cash and cash equivalent due to a transaction there would be inflow of cash and if there is a decrease in cash and cash equivalent due to a transaction there would be outflow of cash. For example, cash sale would cause cash inflow and cash purchase would cause cash outflow. Cash flow statement provides information to the stakeholders about the ability of the enterprise to generate cash and cash equivalent along with certainty of their generation. Cash flow statement shows the inflows and outflows of cash and cash equivalents of an organisation for a particular period. It shows the causes of changes in cash position of an organisation between two balance sheet dates.
Classification of Cash Flows
Cash flows from Operating Activities: A business generates principal revenues from the operating activities. Cash flows from operating activities reveals whether a business enterprise generated sufficient cash from its operating activities.
Example
- Cash sale of goods or provision of services
- Cash payment to the supplier of goods or services
- Cash receipt from royalty, commission etc
Cash flows from Investing Activities: Investing activities cover acquisition and disposal of long-term assets. It also covers investments which are not included in cash equivalents. It shows the expenditure incurred to acquire assets which will generate future revenue for the enterprise.
Example
- Cash purchase of fixed assets
- Cash receipts on disposal of fixed assets
- Cash payment for long-term investments
Cash flows from Financing Activities: Financial activities causes changes to the owner’s equity and borrowings of an enterprise. Cashflows from the financing activities helps the provider of funds in predicting their claims over the future cashflows of the company.
Example
- Cash proceeds from issuance of shares
- Cash receipts from borrowing
- Cash repayment of borrowings
Conclusion
Cash flow statement is prepared classifying all cash inflows and outflows under operating, investing and financing activities. Therefore, it shows the cash flows from operating, investing and financing activities. It helps to identify the ability of an organisation to generate cash and cash equivalent. It also helps in analysing the sources of generation and utilisation of funds. Cash flow statement is not a substitute for profit and loss account and balance sheet but complementary to them.