Definition of Cash Flow Statement
Cash flow statement is one of the three most important financial statements of the organisation, which is prepared with the purpose of showing how much cash is available with the organisation at a specific point of time by taking into account the opening balance of the cash at the beginning of the year along with the movements of cash to arrive at the closing cash balance of the organisation at the end of the year.
The cash flow statement is prepared to show the cash balance of the organization at a specific period of time. It does not show the accruals and prepayments balances in it. Only the organisation’s cash balance is shown under the cash flow statement, which can be obtained by two methods, i.e. Direct method and Indirect method and which is prepared using the cash method of accounting.
Purpose of Cash Flow Statements
The following are the purposes of Cash Flow statements:
- Calculation of the entity’s cash balance: The most important purpose of the cash flow statement is the determination of the cash balance of the entity at some specific period of time. When we say the cash balance, it contains the details of only the cash movements of the organization. The accounting function of every organization contains various methods of recording revenue and expenses like accruals and prepayments. In accruals, the revenue is already earned but yet to be received in some future period, or the expense is already incurred but to be paid in some future date. So, whatever the movement of cash is there, it will take place in some future date. Hence, we cannot determine the actual cash movement for that particular time period in the case of accruals. Likewise, in prepayments, the cash is already paid in the current period of time; however, the expense is yet to be incurred at some future date. Here also, the cash for the future period is paid in the current period, and therefore the actual cash balance of the present period of the organisation cannot be determined in case of prepayments also. So, the main purpose of the cash flow statement is the determination of the actual cash movement of the organisation without taking into account the accruals and prepayments or any other non-cash transaction of the organisation and only following the cash method of accounting.
- To check the organisation’s liquidity: A cash flow statement is prepared to calculate or determine the organisation’s cash balance at the given specified period of time. So, the organisation can have an idea of its operating cash flow when the liquidity of the organisation can be determined. When the organisation’s liquidity position is known to it, the organisation can decide what it can afford or what it can’t afford. Also, the cash available for use in the case of any emergency situation can be determined.
- Assessment of changes in balance sheet items: In cash flow statements, the cash inflows and the cash outflows of the organisation can be determined. The given information of cash inflows, cash outflows, and the balance of cash in hand helps to determine the changes in assets, the changes in liabilities, and the changes in equity for the balance sheet. From this, the organisation’s performance can be measured, which forms the organisation’s proper accounting equation.
- To determine future predictions: With the help of the available information regarding the liquidity of the organisation’s cash position at present, the future liquidity position of the organization can also be determined. A cash flow statement can be used to create future projections of any particular project, which helps the organization make its long-term business plans with the proper availability of expected cash in the future. This will also give the organization the proper time for arranging the cash for future projects if it finds that the lesser cash will be available to it in the future, considering the present liquidity of the cash. The management can make the better strategies for the future considering the current available cash balance.
- To find the cash balance from different activities: In the Cash flow statement, the cash movements from different activities of the organization is calculated, like operating activity, investing activity, and financing activities. The organisation gets the idea of how much net cash is generated from its different activities and sectors, and hence it becomes easy for the organization to manage its cash balance according to different sectors or activities. Also, non-cash generating activities are determined using the cash flow statement by the organization.
- To fulfil the organisation’s legal requirements: It is one of the most important requirements for every organization to prepare the cash flow statement according to the accounting standards and IFRS. When the regulations of the accounting standards and the IFRS along with other legal requirements are properly followed by the organization regarding the preparation of the cash flow statement, it gives confidence to the investors and makes them sure that their money is safe and they can be sure that any fraud which can happen by anyone can be detected at the early stages without having any threat for the future period.
The cash flow statement is the most important financial statement of the organization. It gives detailed information on the cash inflows and cash outflows along with the activities from which the cash is generated. So, it helps the organization to be prepared for any financial crunch it can face in the future. Also, the proper cash flow statement helps to eliminate any creative accounting illusion of the organization. The cash flow statement prepared with the guidelines of the legal requirements attracts the investors to boost their investments in the organization. So every organization should prepare the cash flow statement following the guidelines of the different legal requirements.
This is a guide to the Purpose of Cash Flow Statement. Here we also discuss the definition and purpose of the cash flow statement along with an explanation. You may also have a look at the following articles to learn more –