Finance Plan

Finance Plan

INTRODUCTION

The cash flow statement is the fourth financial statement that businesses prepare. The objective of the cash flow statement is to identify the change in cash during the year, including both the ending cash position of the firm and the sources and uses of cash in the business over the last year. The format and content of the cash flow statement have evolved over time, as a result of an increased emphasis on the cash position of a business (Boehrer, 1993).

Net income, measured using accrual accounting, is considered to be the best indicator of current and future earnings of the business. Both creditors and investors want to invest in businesses that will be profitable, as a business that is not profitable over the long term will not be able to pay interest and principal to its creditors, nor will it be able to pay dividends to investors. The share price of a business that continually incurs losses will plummet, not increase.

It is possible, however, that a profitable business will be unable to meet its obligations as they fall due as a result of inadequate cash on hand. A growing company may be acquiring more capital assets and inventory, and accounts receivable may be growing in proportion to the growth in sales, leaving the firm with very little cash on hand. Accordingly, presenting an income statement alone does not provide users of the financial statements with adequate information to assess the future prospects of the business (Carr, 2000). While a quick glance at the balance sheet can inform the users of the change in cash from the beginning to the end of the year, and the amount of cash on hand at year end, it is much more difficult to assess why the available cash on hand has changed. The cash flow statement provides this information.

Format of the Cash Flow Statement

The cash flow statement reports cash flows under three categories: operating activities, investing activities, and financing activities. All sources and uses of cash must fall under one of these three categories (Cater, 1999).

Operating activities

Operating activities are the income generating activities of the business and are reported on the income statement. The operating activities sections of the cash flow statement report the cash provided or used by the business when generating revenue and incurring expenses. Another way of looking at the operating activities section of the cash flow statement is as the income statement on a cash basis instead of an accrual basis. The operating activities should be the primary source of cash for a business over the long term, although in periods of growth operating activities may actually use funds.

Use of the accrual basis for preparation of the income statement means that there are revenues and expenses recorded in period, even though the cash will be received or paid in a different period. To convert accrual income to cash basis income, it is necessary to adjust for changes in accounts receivable, unearned revenue, accounts payable, inventory, ...