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Cash Flow Statement

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Introduction: CFS can be considered as a financial statement which aggregates all the data relevant to the inflow of cash in an organisation. The CFS includes all the outflows of cash with respect to the payment of several business activities along with the investment made within a specific period of time. This assignment analyses the purpose of statement of cash along with assessing its several aspects. The assignment also discusses direct and indirect method along with the involvement of necessary steps in preparing CFS. The assignment also discusses about the classifications of CFS.

Question 1: Discussion of CFS:

i. Explanation and purpose of the statement of cash.

Answer: CFS is considered as one of the main financial statements. This financial statement report consists of the generation of cash along with the expenditure of cash within a fixed time period. According to the words of Miao, Teoh & Zhu (2016), CFS is considered as a common factor between the income statement and balance sheet. There are three elements of CFS, which are, operating activities, investing activities and financing activities. These elements are necessary to prepare the statement which will be used by managerial accounting in providing information related to investment along with inflow and outflow of cash.

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The main purpose of the cash flow is to identify the flow of cash within an organisation during a stipulated time period. CFS works in unison with managerial accounting as it assists the firm in identifying, analysing, measuring and interpreting information so as to accomplish the goals of the organisation. The Financial reports aids in providing information to the investors as well as creditors so that they can assess the timing and amounts from dividends and interest. As opined by Gordon et al., (2017), the CFS presents the inflows of cash along with outflows of cash in a financial report. The purpose of the CFS also includes an explanation of the changes in cash, legal requirements and anticipation of future flow of cash.

ii. Classification of cash flows.

Answer: The cash flows are classified into:

• Operating Cash Flow

Operating cash flow is considered as a measurement of the sum of cash generated by the firm through its business operations. According to the words of Stice et al., (2019), operating cash flow aids in indicating the rate of generation of cash flow in order to grow and sustain its operations. Flow of cash generated from operational activities generally includes cash flows related to purchases, sales and other expenses. In the views of Ball et al., (2016), operating cash flows focuses on the inflows and outflows of cash with respect to several business activities such as purchasing and selling of inventory along with salaries and wages of the staff or employees. The operating cash flow can be presented in either direct presentation or indirect presentation. Operating cash flow is considered as an important part of the financial report as financial analyst prefers to look at operating cash flow report so as to have a keen understanding of business operations. This element is considered as the main elements which distinguishes between two methods involved in preparing the statement for CFS

• Investing Cash Flow

Investing cash flows refers to the CFS which reports the sum of change of cash within a firm with respect to the profit or loss due to an investment. According to the words of Robinson and Sensoy (2016), the reports reflect the change in the capital of the company due to an investment in advanced technologies and tools. The flow of the cash can be positive or negative, however, as stated by Christersson, Vimpari & Junnila (2015), there are times when company have negative flow of cash due to heavy expenditure regarding investments. Flow of cash due to investment activities is one of the important aspects of financial reports as it reflects upon the capital and growth of the company. The investment activities mainly reflect the sum investment in PPE (plant, property and equipment) along with capital expenditure. Capital expenditure refers to the measurement of capital investment with respect to the evaluation of the stock.

• Financing Cash Flow

Financing cash flows can be considered as the CFS that shows the amount invested in funding the firm. Some of the financing activities involved in CFS are debt, dividends and equity. As per the views of Chen & Teng (2015), financing cash flow allows the investor to understand the organisation's financial strength along with understanding the management of firm's capital structure. It also provides a better understanding of the company's financial condition.

The different types of flows of cash such as operating cash flows, investing cash flow and financing cash flow are all parts of financial reports which is necessary in managerial account in order to provide the investors an insight into the company expenses and gain through sales, investment and funding of the company.

iii. Format and sections of cash flow statement.

Answer: The CFS is divided into three section operating, investing and financing activities and it follows and activity format.

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iv. Steps in preparing cash flow statement

Answer: There are two methods through which CFS can be prepared:

• Indirect method

• Direct method

It should be noted that irrespective of the methods used to prepare a CFS the conclusion will always be the same for both the method. For this assessment only indirect method will be used to prepare a CFS.

1. Preparation of CFS using indirect method:

In order to prepare CSF it is necessary to calculate all the parts of cash statement flow such as operating activities, investing activities and financing activities.

Step 1: Calculation of operating activities

The flow of cash under operating activities is calculated in two stages:

Stage 1: Calculating of profits before any changes in capital

Sum up all the non-cash and non-operating items such as depreciation, loss related to fixed asset along, dividend paid with other such aspects.

Stage 2: Calculations after considering change in the capital

In this stage current assets along with current liabilities are calculated.

Therefore, it can be said that in order to calculate operating activities, the formula provided below needs to be followed:

Cash from operating activities = Calculating of profits before any changes in capital + total depreciation in present assets + total benefit in present liabilities - total increase in present assets - total depreciation in present liabilities

Step 2: Calculation of investing activities

In order to calculate flow of cash due to investing activities, we need to sum up all the inflows of cash related to the sale as well as maturity of any asset along with deducting all the outflow of cash related to payment or purchases of any fixed assets or investments. For instance, inflow of cash from investing activities will include:

• Sale of machinery or any plant, building, furniture, land in cash

• Sale of investments related to shares as well as debentures of different companies in cash

• Receipts of cash related to the collection of loan from third parties

Outflow of cash from investing activities will include:

• Purchase of fixed assets such as machinery, land or building

• Purchase of intangible assets

• Purchase of debentures or shares

• Loan provided to their parties

Step 3: Calculation of financing activities

To calculate flow of cash from financing activities it is necessary to calculate all the cash received or paid from different activities such as shareholder's capital and long-term liabilities. For instance, inflow of cash form from financing activities will include:

• Issue of equity for cash

• Issue of debentures for cash

• Issue of bonds for cash

• Issue of share capital for cash

Outflow of cash form from financing activities will include:

• Paying back to the shareholders in the form of dividends

• Repayment of loans

• Buying equity shares back

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v. Statement of cash flows- direct method

Answer: The direct method of preparing CFS focuses on the information of actual flow of cash from the firm's operations rather than the firm accounting values. As per the views of Nwanyanwu (2015), direct method is preferred over indirect method only when there is a need to assess the cash receipts from activities and payments. The flow of cash in financing and investing activities will be same for both the direct method as well as indirect method.

vi. Statement of cash flows- indirect method

Answer: The indirect method of preparing CFS involves several aspects such as managing the net income with respect to the change in the balance sheets. According to the views of Foerster, Tsagarelis & Wang (2017), indirect method is preferred over direct method as all the information related to the cash inflows and outflows are available which makes preparing CFS using indirect method easier. To prepare a CFS using indirect method it is necessary to calculate the flow of cash from operating activities, investing activities and financing activities. However, as opined by Robinson et al., (2015), this method is less favoured as compared to direct method as this does not provide a comprehensible view of the flow of cash through as business.

vii. Direct versus indirect method of cash

Answer: The statement of flow of cash has three aspects which are considered while preparing the CFS. These three elements are operating activities, investing activities and financing activities. As per the views of Karlan et al., (2016), the main distinct factor between direct and indirect method is the calculation of flow of cash from operating activities. However, there is not any other major difference between these two methods. As opined by Glaum, Schmidt & Schnürer (2016), it should also be understood that the end result after implementing any of the methods provides the same result. Indirect method while calculating flow of cash in operating activities starts form the net income of the firm along with adjusting it in order to convert the total accounting of net income into the flow of cash from operating activities. However, direct method of CFS does not begin with the net income of the company but with the amounts paid and received in cash by the corporation.

Summary of the discussion: Therefore, to summarise the discussion, CFS is a financial statement that provides an insight into the change in the balance sheet along with the incoming affecting cash as well as cash equivalents. The CFS can be prepared using indirect method as well as a direct method. However, the conclusion would be same for both the methods. However, the only difference is the calculation of cash flow due to operating activities.

Conclusion: The CFS helps the organisation to acknowledge the management process through which all the debts are cleared along with the funding of operating expenses. The CFS is considered as an important part of an organisations financial report. Direct method and indirect method are two ways to prepare a CFS. However, direct method assess the operating cash receipts, whereas, information required preparing a CFS using indirect method is easily available.

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