Updated July 14, 2023
Definition of Purpose Cash Flow Statement
The cash flow statement is one of the three most important financial statements of the organisation, which prepare 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.
Explanation
The cash flow statement prepares to show the organization’s cash balance at a specific period. It does not show the accruals and prepayments balances in it. Only the organization’s cash balance is shown under the cash flow statement, which can obtain by two methods, i.e., the Direct method and the Indirect method, and which prepare 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 to determine the entity’s cash balance at some specific period. 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 receive in some future period, or the expense is already incurred but to pay on some future date. So, whatever the cash movement is there, it will occur at 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. Therefore the actual cash balance of the organization’s present period cannot be determined in the case of prepayments also. So, the main purpose of the cash flow statement is to determine the actual cash movement of the organization without taking into account the accruals and prepayments or any other non-cash transaction of the organization and only following the cash method of accounting.
- To check the organization’s liquidity: A cash flow statement prepare to calculate or determine the organization’s cash balance at the specified period. So, the organization can have an idea of its operating cash flow when the liquidity of the organization can be determined. When the organization’s liquidity position is known, it can decide what it can or can’t afford. Also, the cash available for use in the case of any emergency can be determined.
- Assessment of changes in balance sheet items: The organization’s cash inflows and outflows can be determined in cash flow statements. The given information on cash inflows, cash outflows, and the balance of cash in hand helps to determine the changes in assets, liabilities, and equity for the balance sheet. From this, the organization’s performance can be measured, which forms the organization’s proper accounting equation.
- To determine future predictions: With the help of the available information regarding the liquidity of the organization’s cash position at present, the future liquidity position of the organization can also be determined. A cash flow statement can create future projections of any particular project, which helps the organization make its long-term business plans with the proper availability of expected cash. 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 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 organization activities are calculated, like operating activity, investing activity, and financing activities. The organization gets the idea of how much net cash is generated from its different activities and sectors. 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 organization’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 organization properly follows the regulations of the accounting standards, IFRS, and other legal requirements in preparing the cash flow statement, it instills confidence in the investors. It 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 any threat in the future.
Conclusion
The cash flow statement is the most important financial statement of the organization. It gives detailed information on the cash inflows and outflows and the activities from which the cash is generated. So, it helps the organization to prepare 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 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.
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