The Statement of Cash Flows
In the financial accounting context, a cash flow statement refers to a financial statement showing the manner in which the balance sheet account changes as well as income influence cash and cash equivalents. Essentially, the cash flow statement focuses on the inflow and outflow of cash in a business. However, it is not the easiest of the basic financial statements to prepare as many people believe.
Preparation of a cash flow statement is not an easy task since it does not merely entail a comparison of the beginning and ending cash balances on the balance sheet. The cash inflows and outflows must be identified as one of the concepts in the management of finances (Kordestani, Bakhtiari, & Biglari, 2011). Cash inflow refers to the amount of money generated or received in an organization. On the other hand, cash outflow is the money spent by an entity. Both the outflows and inflows of cash must have a tangible quantity attached to them (Sayari & Mugan, 2013). The difference between the cash inflows and outflows is the total amount of savings generated or debt incurred by a specific entity. Additionally, the statement of cash flow must be handled carefully as it is a reflection of the actual amount of money received by an entity from the operations. Many people find it difficult to prepare cash flow statements because it is the only financial statement that is mostly prepared based on cash and not accrual. The adjustment of accounting records to exclude items that are not cash items can be demanding.
Various sections that are covered by the cash flow statement need to be understood before one can accurately prepare the statement. However, there are challenges associated with the three major parts of the cash flow statement (Sayari & Mugan, 2013). Cash generated from business operations, investment, and financing activities must be properly reviewed before coming up with an accurate financial statement and is vital in relating the financial information of similar companies (Kordestani, Bakhtiari & Biglari, 2011). Difficulty in the realization of this goal can be linked to various ways in which definite transactions are categorized. The accounting field has ignored the attempt to carry out the comparison, although analysts have come up with various measurements in this regard. Difficulty in comparison arises in the way paid dividends and interests are handled. Paid dividends are classified as financing activities, while paid interests are categorized as operating activities (Sayari & Mugan, 2013). Both payments are a form of interest generated on money that is borrowed to finance the business organization, yet one negatively affects operating cash flow.
A challenge faced in the preparation of a cash flow statements is the way companies treat their base of receivables. Previously, receivables were utilized as security for borrowing, and the borrowed money was classified as a financing activity (Sayari & Mugan, 2013). Currently, the receivables are sold. Earnings generated from such sales are categorized as an operating activity. Analysts believe that the cash generated from operations may be inaccurately inflated. Redeeming of stock options in payment of deferred compensation is often classified as a financing activity (Kordestani, Bakhtiari & Biglari, 2011). However, the transaction’s actual nature must be fall under the category of operating activity, particularly when the transaction takes the form of employee wages paid. Thus, it is a daunting task to match activities within the cash flow statement. The category of investing upholds the rule that only a transactional amount of cash should be indicated (Sayari & Mugan, 2013). This implies that if an entity purchases another for $500 million but only utilizes cash of about $100 million, the amount indicated on the statement of the cash flow will be $100 million. The $400 million left in the form of equity instruments could be buried in the financial statements as a footnote translating to a high possibility that the reader’s impression of the transaction cost may be false.
Overall, I do not agree that preparing a cash flow statement is the easiest of the basic financial statements. There are a number of challenges encountered in the preparation of the statement of cash flows, which make it more difficult to use when compared to other basic financial statements.
Kordestani, G., Bakhtiari, M., & Biglari, V. (2011). The ability of combinations of cash flow components to predict financial distress. Business: Theory and Practice, 12(3), 277-285. Retrieved from https://bjrbe.vgtu.lt/index.php/BTP/article/download/8698/7620
Sayari, N., & Mugan, F. C. S. (2013). Cash flow statement as evidence for financial distress. Universal Journal of Accounting and Finance, 1(3), 95-103. Retrieved from http://www.hrpub.org/download/20140105/UJAF2-12201737.pdf