Question

why is the cash flow statement important? How does it differ from the income statement?Describe the significance of each of the three major sections of the cash flow statement in detail.

Answer 1

Importance of cash flow statement

• It helps to analyse cash position in business.
• Bank can understand repayment capacity by analysing this statement before giving loan to business organisation.
• It helps to understand causes of poor cash position.
• It assess ability to generate cash through business operations.
• Helpful in short term decision making.

How it is different from income statement

Income statement    Cash flow statement

It is prepared on accrual basis(Expenses and income of particular period It is prepared on cash basis

is considered

Cash and non cash expenditure are considered   Only cash expenses are considered

To asses the firm's profitability To assess the liquidity and solvency.

Major sections of cash flow statement

• Operating activities Cash inflows and outflows from revenue and expenses.Many adjustments are made to net income to calculate the amount of cash flow from operating activities.Increase or decrease in current asset or current liabilities are considered.There are two methods to calculate cash flow from operating activities - Direct method and indirect method.
• Investing activities Cash inflow and cash outflow from sale or purchase from investment and long term assets.For example- purchase of building,Sale of equipment,Interest received.
• Financing activities Cash inflow and outflow from long term debt and equity transactions.For example - cash repaid to bondholder or bankers or Preferred stockholder,Issue of stock,Dividend paid.