Cash Flow Statement: Importance, Objectives & Limitations

A Cash Flow Statement is similar to the Funds Flow Statement, but while preparing funds flow statement all the current assets and current liabilities are taken into consideration. But in a cash flow statement only sources and applications of cash are taken into consideration, even liquid asset like Debtors and Bills Receivables are ignored.

A Cash Flow Statement is a statement, which summarises the resources of cash available to finance the activities of a business enterprise and the uses for which such resources have been used during a particular period of time. Any transaction, which increases the amount of cash, is a source of cash and any transaction, which decreases the amount of cash, is an application of cash.
Simply, Cash Flow is a statement which analyses the reasons for changes in balance of cash in hand and at bank between two accounting period. It shows the inflows and outflows of cash.

Objectives of Cash Flow Statement
The Cash Flow Statement is prepared because of number of merits, which are offered by it. Such merits are also termed as its objectives. The important objectives are as follows:

• To Help the Management in Making Future Financial Policies: Cash Flow statement is very helpful to the management. The management can make its future financial policies and is in a position to know about surplus or deficit of cash.

• Helpful in Declaring Dividends etc.: Cash Flow Statement is very helpful in declaring dividends etc. This statement can supply necessary information to understand the liquidity.

• Cash Flow Statement is Different than Cash Budget: Cash budget is prepared with the help of inflow and outflow of cash. If there is any variation, the same can be corrected.

 Helpful in devising the cash requirement: Cash flow statement is helpful in devising the cash requirement for repayment of liabilities and replacement of fixed assets.

• Helpful in finding reasons for the difference:  Cash Flow Statement is also helpful in finding reasons for the difference between profits/losses earned during the period and the availability of cash whether cash is in surplus or deficit.

•  Helpful in predicting sickness of the business:  Cash flow is helpful in predicting sickness of the business. A sound cash position is a true indicator of sound financial position.

Importance of Cash Flow statement:

i. Short-term financial Planning: Cash flow statement provides useful information which helps the management in taking short-term investment decisions.

ii. Helpful in preparing Cash Budget: A Cash Budget is an estimate of cash receipts and disbursement for a future period of time. Cash Flow Statement provides help to the management to prepare Cash Budget. A comparison of cash budget and cash flow statement reveals the extent to which the sources of the business were generated and used as per the plans of the business.

iii. Measurement of Liquidity: Liquidity means ability of a business enterprise to pay off its liabilities when due. Cash Flow Statement helps to know about the sources where from the cash will be available to pay off the liabilities.

iv. Dividend Decisions: The Capacity of the firm to pay dividends to shareholders depends on the generation of cash flows. Cash flow statement helps the management to know about the sources of cash to pay off dividend.

v. Prediction of Sickness: With the help of preparing cash from operation a business enterprise may come to know about cash losses in operation. It helps to predict this type of sickness.

vi. Future Guide: Most of the users are interested to assess the ability of the firm in generating future cash flows, its timing and certainty. These questions can be answered by analysing the cash flow statement.

vii. The use of cash in investing and financing Transaction: Information in cash flow statement would be useful to find out as to how cash has been obtained from investing and financing activities and how cash has been used to invest and repay borrowings etc. The statement would be useful to users to ascertain the following:

a) The change in the net assets of the business.
b) The change in the financial structure.
c) The financing of expansion.
d) The utilisation of finance obtained by the enterprise.
e) The impact of investing and financing activities on the cash balance of the enterprise.

Limitations of Cash Flow Statement:
Though the Cash Flow Statement is a very useful tool of financial analysis, it has its limitations which must be kept in mind at the time of its use. These limitations are:

i. Non-cash Transactions are ignored: The Cash Flow Statement shows only inflows and outflows of cash. It does not show non-cash transactions like the purchase of buildings by the issue of shares or debentures to the vendors or issue of bonus shares.

ii. Not a substitute for an Income Statement:  An income statement shows both cash and non-cash items. The income statement shows the net income of the firm whereas the Cash Flow Statement shows only the net cash inflows or outflows which do not represent the net profits or losses of the enterprise.

iii. Historical in Nature: It rearranges the existing information available in the income statement and the balance sheet. It will become more useful if it is accompanied by the projected Cash Flow Statement.

iv. Ignorance: It ignores basic accounting concept, i.e., accrual concept.

v. What is Cash: It is difficult to precisely define the term ‘cash’. There are controversies over a number of items like cheques, stamps, postal orders, etc. to be included in cash.

vii. Does not reveal true liquidity position: A Cash flow statement reveals the inflow and outflow of cash but the exclusion of near cash items from cash obscures the true reporting of the firm’s liquidity position.

vii. Working Capital ignored: Working Capital being a wider concept of funds, a funds flow statement presents a more complete picture than cash flow statement.