IGNOU : M.COM : MCO 5 : UNIT 7 : Q - 1. How cash flow statement is different from income statement? What are the additional benefits to different users of accounting information from cash flow statement?

 Ans. CASH FLOW STATEMENT VS. OTHER FINANCIAL STATEMENTS

The cash flow statement is different from other principal financial statements in many different ways. Financial statements like P&L account and Balance Sheet are prepared using accrual accounting principle. For instance, when a firm sells its products, it is assumed that profit is realised. It is assumed as a going concern, the firm will eventually realise its profits. Similarly, the expenses incurred against the sale are assumed to have incurred or paid irrespective of the fact whether cash is paid or not. Interest expenses are charged against profit though it is an outcome of financing decision. Several non-cash expenses like depreciation are also charged against profit. On the other hand, cash flow statement is prepared on the principle for cash accounting concept. It is simply a summary of cash book classified under three headings namely cash flow from operating, investing and financing activities. In a broad context, the cash flow from operating activities culls out all Profit and Loss Account entries of cash book (like sales, material, wages, etc., and summarise the same. The cash flow from investing activities summarises all the assets side entries like purchase of fixed assets, sale of fixed assets, etc., of cash book. Finally, the cash flow from financing activities summarises all the liability side entries like borrowing, repayment, fresh equity, etc. of cash book. The following table shows the Cash Flow Statement of a company, which simply summarises the cash book entries under different headings, which are easily readable.

USES OF CASH FLOW STATEMENT

Cash flow statement is very useful to the financial management. It is used as a tool for financial analysis for short term planning. The preparation of cash flow statement has several uses. The more important uses are as follows:

1) Changes in cash balance between two points of time and the contributing factors for such change are clearly revealed.

2) The cash flow statement explains the reasons for:

i) the presence of very low cash balance in-spite of huge operating profits: or

ii) the presence of a higher cash balance in-spite of a very low level of profits

3) Projected cash flow statements help the management in short-term planning and several other ways like:

i) Determination of additional cash requirements during a given period and making timely arrangements

ii) Identification of the size of surplus and the time for which such surplus funds are likely to be available

iii) Judging the ability of the firm to repay/redeem debentures/preferences shares.

iv) Examining the possibility of maintaining/increasing dividends

v) Assessing the capability of finance, replacement of fixed assets

vi) Assessing the capacity of the firm to finance expansion.

vii) More efficient and effective management of cash flows.