Cash Flow Statement — Meaning and Objectives

A profit and loss account tells the owners how much profit a business made, and a balance sheet tells them the financial position on a particular date — but neither directly answers a very practical question: where did the cash come from during the year, and where did it go? A firm can be highly profitable on paper and still run short of cash (because its profits are locked up in stock and debtors), or it can show a modest profit yet have plenty of cash. The Cash Flow Statement exists precisely to explain the movement of cash.

A Cash Flow Statement is a statement that shows the inflows (sources) and outflows (uses) of cash and cash equivalents of an enterprise during a given accounting period, classified under three heads — operating activities, investing activities, and financing activities — and reconciles the opening and closing balances of cash and cash equivalents. In India, its preparation and presentation are governed by Accounting Standard 3 (AS-3), 'Cash Flow Statements'.

Objectives of preparing a Cash Flow Statement:

• To show the sources and uses of cash during the period, so that users can see exactly how the closing cash balance was arrived at from the opening balance.
• To assess the liquidity and solvency of the enterprise — its ability to generate cash and to meet its obligations as they fall due.
• To explain the reasons for the difference between profit and cash. It reconciles why a profitable firm may have less cash, or a low-profit firm more cash, at the year end.
• To help in short-term financial planning. By revealing the pattern of cash generation and use, it helps management plan for future cash needs and surpluses.
• To evaluate the firm's ability to pay dividends, repay loans and finance growth out of the cash it generates from operations. …