Question

In your estimation, what is the principal limitation of the statement of cash flows? Explain in significant detail.

Answer 1

Answer

Cash flow statement (CFS) is a financial statement which shows the flows of cash and cash equivalent (C&CE) of a particular period.

Explanation

Cash flow statement (CFS) is a financial statement which shows the flows of cash and cash equivalent (C&CE) of a particular period. It shows the cash outflows and inflows of an enterprise. It classifies the cash flow activity in three different categories i.e. investing activities (IA), operating activities (OA), and financing activities (FA).

Limitations of CFS are:

(1) It shows the Outflows and inflows of Cash transactions only and non-cash transactions are ignored. Hence, cash balance of the company doesn't shows the true liquidity position of the company.

(2) Net income of the company is different from the Net cash flow computed using the Cash flow statement because net income is computed by taking into consideration both the non-cash as well as cash items of the company.

(3) Cash flow statement is not considered as a substitute of the income statement of the company.

(4) Cash flow statement is prepared based on the data of balance sheet. So, if the balance sheet data is incorrect, then the cash flow statement also shows the incorrect pictures of the company's cash position.

(5) Cash flow statement is prepared on the cash basis of accounting concepts. Hence, its accuracy is questionable as accrual basis transactions are ignored.