There are three types of financial statements to study the firm’s financial position.
1. Income Statement
2. Balance Sheet
3. Cash Flow statement
Income statement helps to understand how profitable the company is, Balance sheet tells about the company’s financial resources but these do not tell about the sources and uses of cash to meet operation and liabilities, if you want to track an in and the outflow of cash flow then Cash flow statement is the statement which helps to understand the components related to cash.
Cash flow statement has gained substantial importance in the last decade because of its practical utility to the users of financial information.
Cash flow statement has three components which provide information about the historical changes in cash and cash equivalents of an enterprise. These are:-
· 1. Cash flows from operating activities – This section gives a good idea of how much cash a company brings in, or uses, during its normal course of business. It includes the cash received from customers and cash payments to suppliers for incoming raw material and government for taxes.
· 2. Cash flows from investing activities This section counts the cash consumed buying new assets such as equipment or facilities.
· 3. Cash flows from financing activities This section tells about how much cash in by lenders and investors and cash used to pay cash dividends to investors or to pay down debts.
Here, the important point to remember is the number is positive if the cash brings in a company and negative when the cash out from the company.
However, the information received from the cash flow statement, sections are useful and help an investor to understand the cash in and out of a company but the investor can easily understand the company’s free cash flow to pay bills by using a simple formula
Free cash flow = Cash flows from operating activities – Capital Expenditure.
If an investor is interested in further, know the company’s year supply of cash then it can simply find by putting values in another formula:-
Year’s supply of cash = Cash and Cash equivalents / Free cash flow
Note:- if a number followed by negative sign then it means the cash burned by the company.
Benefits of Cash Flow Statement
· A cash flow statement when used along with other financial statements provide information that enables users to evaluate changes in net assets of an enterprise, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timings of cash flows in order to adapt to changing circumstances and opportunities.
· Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different enterprises.
· It also enhances the comparability of the reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events.
· It also helps in balancing its cash inflow and cash outflow, keeping in response to changing condition.
· It is also helpful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow and impact of changing prices
· Cash flow statement is providing the information to investors about the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise to utilise those cash flows.
Cash management is an important factor to know the firm’s management capability to optimum use of the inflow and outflow of cash to carry out short term and long term operation and investment for the welfare of company and shareholder.