undestanding cash flow statement

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Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comHow to Read Cash Flow Statement

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comWhat is Cash Flow Statement?

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comIt is a statement which provides information about the historical changes in cash and cash equivalent of the entity.

It provides the user of financial information with a basis on which to assess the ability of the entity to generate cash and its needs to utilise that cash.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comA statement of cash flows classifies cash flows during the period into:

Operating activity

Investing activity and

Financing activity

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comDefinitions

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comCash comprises cash on hand and demand deposits

Cash equivalents are held for meeting short term cash commitments rather than for investment or other purpose. For an investment to qualify as cash equivalent it must be:

Readily convertible to a known amount of cash i.e. it has short maturity andSubject to an insignificant risk of changes in value

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comOperating Activities are the principal revenue producing activities of the enterprise and other activities that are not investing or financing activities.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comInvesting Activities are the acquisition and disposal of long-term asset and other investments not included in cash equivalent.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comFinancing Activities are the activities that result in changes in the size and composition of equity capital and borrowings of the enterprise.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comWhat do these Activities indicate?

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comOperating Activities

It indicates to what extent the operations of entity have generated cash flows which are available for use in other activities.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comInvesting Activities

It indicates extent of expenditure made in resources intended to generated future income and cash flows.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comFinancing Activities

It is useful in predicting the claims that outside providers of capital will have over the future cash flows.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comHow to evaluate cash flows from these activities?

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comOperating Activities

Since this activity represents internal cash generation it is always better to have positive and increasing cash flows from operating activity.

Negative cash flows from this activity indicates that the entity is incurring cash losses

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comInvesting Activities

Since this activity indicates flow of investment in and out of business for future profit generation, it is better to have negative cash flow here i.e. outflow.

Positive cash flow or inflow of cash in this activity indicates that the entity is selling its resources to generate cash, which is not good.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comFinancing Activities

This activity indicates change in capital structure i.e. equity or borrowing. While there is a limit to increase the equity capital (authorised share capital) the major volatile component here is borrowing

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comFinancing Activities

Negative cash flow i.e. outflow in this activity would mean that the entity is reducing its debt, there by reducing interest burden which is quite good.

Positive cash flow here indicates increasing debt burden, which should be avoided.

Roshankumar S PimpalkarEmail: roshankumar.2007@rediffmail.comComparison of cash flow statement of more than one year can easily help to assess the solvency and liquidity position of an entity.

Roshankumar S Pimpalkar

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