Statement of Cash flows



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Statement of Cash flows

Introduction

The cash flow statement is one of the financial statements that exhibits changes incurred in the accounts of balance sheet and affects on cash and cash equivalents as a result of change in income level. In addition, it further divides the statements into operating, investing and financing activities. The main purpose of cash flow statement is to exhibit the inflow and outflow of cash from or out of the business. It is a helpful tool in identifying the short term feasibility of the business. It indicates the company's ability to pay short term bills and obligations as they come due.

Difference in Direct and indirect method of preparing Cash flow statement

The statement of cash flow can be prepared either using direct or indirect method. The direct method is usually considered as a easier of preparing report. The indirect method of cash flow preparation is widely used as per accounting requirement imposed by FAS 95 (Benedicto, 2008).

Direct Method

The direct method of cash flows includes listing all cash flows under the “cash flow from operating activities” of the cash flow statement. The cash inflow represents cash collected from customers and cash outflow represents cash paid to suppliers, employees, and other debtors. This part of cash flow statement also represents cash paid for income tax purposes and interests paid to creditors. The main disadvantage associated to preparation of cash flow statement utilizing direct method is lack of standardized format or form. For instance, a company that is records transaction on accrual basis of accounting shall sum up both cash collected from customers and sales made on credit. In this event, the company shall need to make specialized provisions to track the sales made on cash and credit separately. The direct method of cash flow statement also requires providing a reconciliation of net income to that of cash provided by operating activities.

Indirect method

The indirect method of preparing a cash flow statement involves adjusting net income to be converted from accrual basis to cash basis. It is done by adding back non cash based expenses like depreciation, amortization, and allowance for bad debts associated to accounts receivables and loss incurred on the sale of fixed assets. In addition, it also requires adjusting the changes in net income for the account balances of current assets other than cash and current liabilities for a particular time period. For example, accounts receivables, inventory, supplies, prepaid expenses, and accounts payables.

Cash flow from operating activities

The cash flow generated from operating cash flow is one that a company generates from its revenues or usual operations. The example of operating activities includes production, sales, product delivery and collection of cash from customers. The cash generated from firm's operating activities indicate the company's ability to make profit. The cash flow from operating activities include cash received from sales of goods and services, interest paid, interest income, amount paid to suppliers, salaries paid to employees, purchase of raw material, depreciation, amortization, and deferred taxes, dividends ...