Question

What are the three major components of statement of cash flows? Briefly discuss the relations among there components.

What are the two methods to compile statement of cash flows? Discuss the advantages and disadvantages of the methods.

Answer 1

The three major components of cash flow are : operating activities , financing activities and investing activities. The operating activities focus on the day to day operations of the business along with reporting the changes in the working capital. The investing activities focus of the purchase and sale of assets. The financing activities states the investment and payment of amounts.

The three components of the cash flow statement focus on representing various aspects of the income statement and the balance sheet. The three components are majorly dependent on each other as the computation of all the three components helps to determine the closing balance of cash. Since all the three components refer to the particular areas, it is easy to reconcile the opening cash balances with the inflows and the outflows in order to determine the closing cash balance.

The two methods to compile the cash flow statement are : direct method and indirect method.

Advantages and disadvantages of direct method are:

Advantages : 1. It is very easy to prepare and understand.

2. They help to categorise all similar transactions under a single category and hence enables to sort all the transactions easily.

3. This method provides more correct and reliable results.

Disadvantages :

1. Since it requires detailed information, it takes a longer time to prepare the cash flow statement using the direct method.

2. The direct method categorises transactions and provides a detailed view of the same enabling sensitive information to be shared with others.

3. All the non cash transactions are ignoring in this method.

Advantages of indirect method of cash flow statement:

Advantages : 1. This method considers all the factors including non cash transactions.

2. It takes less time to prepare the cash flow statement using this method.

3. They are most widely used as they take into consideration various non cash transactions and all the other adjustments required to attain the desired results.

Disadvantages : 1. They are not very accurate due to various changes made.

2. It takes time to prepare the cash flow statement using this method as many adjustments are required to be done