IGNOU : M.COM : MCO 5 : UNIT 7 : Q - 2. How does cash flow statement differ from funds flow statement? What are the uses of cash flow statement?

Ans. DISTINCTION BETWEEN CASH FLOW AND FUND FLOW ANALYSIS

Following are the major points of difference between cash flow analysis and fund flow analysis:

1) Fund flow analysis deals with the change in working capital position between two balance sheet dates, whereas the cash flow analysis is concerned with the change in cash position.

2) Cash flow analysis is more useful as a tool in short-term financial planning, whereas fund flow analysis is more useful in long-term financial planning.

3) An increase in current liability or decrease in current asset (other than cash) results in an increase in cash whereas such changes result in decrease in the net working capital. Similarly, a decrease in any current liability or an increase in current asset (other than cash) results in a decrease in cash, whereas such changes increase the net working capital.

4) Cash flow statement recognizes 'cash basis of accounting' where as funds flow statement is based on accrual basis of accounting.

5) Cash flow analysis explains only the causes of cash variations, whereas funds flow analysis discloses the causes of overall working capital variations.

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.