Conventional financial statements i.e. income statement and balance sheet do not give true picture of the cash flows of the firm. Because income statement incorporates many non-cash expenditures and revenues for the sake of ascertaining profitability. Similarly balance sheet tells us the overall financial position with respect to firms’ assets and liabilities and includes monetary and non-monetary items. In reality the business is a matter of earning cash therefore firms receive and spend cash on daily basis. The shareholder must be in loop regarding the cash receipts and disbursements of the firm. Cash flow statement summarizes the firms’ cash flows over a given period of time under a universally accepted and understood format.
The preparation of cash flow statement is a matter of ascertaining cash inflows and outflows with in a given period mainly one year. It summarizes the cash inflows and outflows. Cash inflows means the sources of cash or cash receipts and cash outflow means the uses of cash or cash payments. For example, if a firm’s accounts payable increased by $1000 during a period, the change would be an inflow of cash. Few points need to be understood for the good insight of cash flow statement.
• The cash invested in assets is treated as funds tied up in those assets therefore any decrease in assets is referred to as cash inflow. On the contrary enhancement in assets or cash balances indicates cash outflows because additional cash has been strapped in assets and cash balances. Likewise decrease in cash balance reflects cash inflow.
• Just like amortization and depletion, depreciation is also a non-cash charge that is deducted from revenue to ascertain the profitability for a period. Depreciation is required to be added to the profit after tax to assess the cash flows from operations in cash flow statement.
• To prevent from double counting of depreciation in cash flow statement it is imperative to include gross rather than net changes in fixed assets while preparing cash flow statement.
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