Q.State the objective of preparing ‘Cash Flow Statement’.
You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.
Start your 14-day free trial to unlock the full solution →The objective of preparing a Cash Flow Statement is to provide a detailed summary of cash inflows and outflows from operating, investing, and financing activities over a specific period, helping stakeholders assess a firm’s liquidity, solvency, and financial flexibility.
The Cash Flow Statement is one of the most important financial statements in Accountancy, especially for Class 12 CBSE and other Indian board exams. It answers a simple but critical question: Where did the cash come from, and where did it go? Unlike the Profit and Loss Account (which follows accrual accounting) or the Balance Sheet (which shows a snapshot), the Cash Flow Statement focuses purely on actual cash movements.
Why is this statement prepared? The core objective
The primary objective is to classify all cash transactions into three distinct activities — Operating, Investing, and Financing. This classification is not arbitrary; it follows Accounting Standard 3 (AS-3) and is mandatory for listed companies. Let’s break down the purpose behind each:
-
To assess the ability to generate cash from operations. A company might show a profit on paper but still run out of cash if its receivables are not collected or inventory piles up. The Cash Flow Statement reveals whether the core business (operating activities) is actually generating cash. This is the most critical insight — a healthy business must eventually generate cash from selling its goods or services.
-
To evaluate investing and financing decisions. By separating investing activities (buying/selling fixed assets, investments) and financing activities (raising loans, issuing shares, paying dividends), stakeholders can see how a company funds its growth and where it deploys its capital. For example, a company selling off its machinery to pay a dividend is a red flag — the Cash Flow Statement makes this visible.
-
To understand liquidity and solvency. The net increase or decrease in cash and cash equivalents (the bottom line of the statement) tells you whether the company’s cash position improved or worsened during the period. This is vital for creditors, banks, and investors who want to know if the firm can meet its short-term obligations.
-
To help in predicting future cash flows. Past cash flow patterns often repeat. If a company has consistently generated strong cash from operations, it is reasonable to expect similar performance in the future — barring major changes.
A common mistake students make is confusing the Cash Flow Statement with the Fund Flow Statement. The Cash Flow Statement deals only with cash and cash equivalents (e.g., bank balances, short-term highly liquid investments). It does not consider working capital changes like credit sales or credit purchases unless they directly affect cash.
For exam purposes, remember the mnemonic OIF — Operating, Investing, Financing. Every cash transaction you encounter must be classified into exactly one of these three buckets. If it doesn’t fit, it’s probably not a cash transaction.
The three activities in detail
| Activity | What it includes | Why it matters |
| :--- | :--- | :--- | …
Unlock everything free for 14 days
- Full step-by-step solutions
- Concept-first explanations
- Methods, shortcuts & mistakes
- PYQ mapping + timed mock tests
Full access for 14 days. No credit card required.