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Definition, Explanation and Purpose of Preparing Statement of Cash Flows:

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Statement of cash flows reports cash receipts, cash payments, and net changes in cash resulting from operating, investing, and financing activities of an enterprise during a period, in a format that reconcile the beginning and ending cash balances.

The primary purpose of Statement of cash flows is to provide information about an entity's cash receipts and cash payments during a period. A secondary objective is to provide information on a cash basis about its operating, investing and financing activities.

Usefulness of the Statement of Cash Flows:

The information in a statement of cash flows should help investors, creditors, and others assess the following:

Future Cash Flows:

A primary objective of financial reporting is to provide information that makes it possible to predict the amounts, timing, and uncertainty of future cash flows. By examining relationship between items such as sales and net cash flow from operating activities, or net cash flow from operating activities and increase or decrease in cash, it is possible to make better predictions of the amounts, timings, and uncertainty of future cash flows than is possible using accrual basis data.

Ability to Pay of Dividend and Meet Obligations:

If a company does not have adequate cash, employees cannot be paid, debts cannot be settled, dividends cannot be paid, and equipment cannot be acquired. A statement of cash flows indicates how cash is used and where it comes from. Employees, creditors, stockholders and customers should be particularly interested in this settlement, because it alone shows the flows of cash in a business.

Difference between Net Income and Net Cash Flows from Operating Activities:

The net income number is important, because it provides information on the success or failure of a business enterprise from one period to another. But some people are critical of accrual basis net income because estimates must be made to arrive at it. As a result, the reliability of the number is often challenged. Such is not the case with cash. Thus readers of the financial statements benefit from knowing the reason for the difference between net income and net cash flow from operating activities. Then they can assess for themselves the reliability of the income.

Non-cash Financial and Investing Transactions:

By examining the company's investing activities (purchase and sales of assets other than its products) and its financing transactions (borrowings and repayments of borrowings, investments by owners and distribution to owners), a financial statement reader can better understand why assets and liabilities increased or decreased during the period. For example, the following questions might be answered:

  1. How did cash increase when there was a net loss for the period?

  2. How were the proceeds of the bon issue used?

  3. How was the expansion in plant and equipment financed?

  4. Why were dividends not increased?

  5. How was the retirement of debt accomplished?

  6. How much money was borrowed during the year?

  7. Is cash flow greater or less than net income?

More study material from this to

More study material from this topic:

Definition, Explanation and Purpose of the Statement of Cash Flows
Classification of Cash Flows
Format and Sections of Statement of Cash Flows
Steps in Preparing Statement of Cash Flows
Statement of Cash Flows - Direct Method
Statement of Cash Flows - Indirect Method
Direct versus Indirect Method of Cash Flows



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