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How to Write a Cash Flow Statement ' Steps

If you need to prepare a cash flow statement, read the article to learn about various tips on how to write a cash flow statement.

Notion of a Cash Flow Statement and How to Write a Cash Flow Statement

Cash is one of the most limited resources. Therefore, success of business is largely determined by the ability of management to rationally allocate and use it. Cash is essential to the enterprise to pay wages, taxes, debt service, purchase raw materials, fixed assets, dividend payment, and so on.

For effective cash flow management it is necessary to know the following:

  • Its value for a certain period.
  • Its structure.
  • Types of activities that form the corresponding elements of the flow and the mechanisms of their formation.

In this regard, the most important cash flow management tool of the company is cash flow statement. This statement is necessary for both managers and external users, like creditors, shareholders, investors, etc. They as a result of its construction and analysis can see the actual income and expenses, as well as get answers to the consecutive questions:

  • From what sources and to what extent the funds were received and what are the main directions of their use?
  • Can the company as a result of its core business provide the excess of cash receipts over the payments?
  • Can the company perform and maintain its commitments?
  • Are there sufficient funds to conduct a core business?
  • To what extent the company can provide investment needs from domestic sources of funds?
  • What explains the difference between the value of profits and cash size?

Cash flow statement is a report on the company’s cash sources and their use in the reporting period, directly or indirectly, reflecting the company’s cash flows with the classification by main sources and its cash payments with the classification of the main areas of use during the period. The report gives an overall picture of operating results, short-term liquidity, long-term creditability, and makes it easier to conduct a financial analysis of the company.

According to the rules on how to write a cash flow statement, cash flow statement is based on the accounting information or data contained in the balance sheet and the profit and loss account, but, unlike them, this statement is not directly associated with the company’s accounting policies, and in this sense is more objective. Presentation of cash flow statement in many countries is mandatory and regulated by law.

History of a Cash Flow Statement

In contrast to the balance sheet and the report on the financial results with a long history, a cash flow statement appeared in the financial system in the 60’s of the 19th century. By the mid of 60’s of the 19th century, a general approach to the preparation of a cash flow statement was formed. It was a document on the use and sources of funds.

The history of a cash flow statement begins from 1863, when the company Dowlais Ironworks, recovering after the crisis, showed a profit in their statement, but it did not have enough money to buy a new blast furnace. In order to explain the lack of funds one of the managers of the company has made a report, which he called the comparative balance sheet. Based on the report, it became clear that the company had too much inventory (apparently they spent considerable resources to buy them). This report on how to write a cash flow statement was the ancestor of a modern cash flow statement.

In 1971, a report on the use and sources of funds in the United States has become a must in the preparation of financial statements in accordance with US GAAP. In 1992, the International Accounting Standards Board developed IFRS 7 cash flow statement, which entered into force in 1994. The standard provided mandatory submission of the report.

A cash flow statement in the current format, when the cash flow was divided into flows from operating, financial, and investment activities, was developed in the US in 1988. To date, all national and international developers of accounting standards have come to the conclusion about the importance of disclosure of revenue sources and use of cash by companies. A cash flow statement became a part of the financial statements package in most countries.

How to Write a Cash Flow Statement: Methods

There are two primary methods of building detailed reports on cash flows – direct and indirect.

  • How to Write a Cash Flow Statement: Direct Method of Construction

The greatest difficulty of constructing cash flow statement with a direct method, in particular for the external analysts, is its first section, where cash flows from operating activities are reflected.

According to the direct method on how to write a cash flow statement, core kinds of gross cash receipts and payments are being revealed. The advantages of this method are the following:

  • Opportunity to show the main sources of inflow and directions of outflow of funds.
  • Ability to make operational conclusions as to the sufficiency of funds for payments under the various current liabilities.
  • Direct connection to the plan cash.
  • A link is being established between the implementation of monetary and revenues for the period.

Information about the main types of cash receipts and payments may be obtained from the company’s accounts and from the balance sheet and the income statement, using the adjustment of the relevant articles.

In the first case, the specialists, responsible for the formation of statements, analyze the cash flows in various accounts of accounting and classify cash flows by type of activity (operating, financing or investing).

However, in practice, most enterprises do a huge number of daily operations that cause cash flows, thus it is quite difficult to analyze and classify cash flows. In this regard, the constructing method on how to write a cash flow statement on the basis of credentials is often too time-consuming even for the internal accounting services. Furthermore, it is unacceptable for external users who do not have access to the credentials of the enterprise constituting its trade secrets.

In this situation, it is more simple and universal to use the data sheet and the profit and loss account with appropriate adjustments.

The disadvantage of this method is that it does not disclose the connection of the obtained financial result and changes of the absolute size of the enterprise funds.

  • How to Write a Cash Flow Statement: Indirect Method of Construction

A cash flow statement in the context of operating activities can be obtained using the indirect method. According to the algorithm of construction, this method it is reverse to the direct one.

Under the indirect method, the net profit or loss of the company is adjusted with the subject to operations of non-cash nature, as well as changes in the operating working capital. Thus, this method does the following:

  • It shows the connection between different types of activity of the enterprise.
  • It establishes the relationship between net income and changes in the working capital of the company for the reporting period.

Under the indirect method, the algorithm of construction the cash flow from operating activities includes the implementation of the following steps:

  • According to the statement, the enterprise’s net profit is determined.
  • The sums of cost items that do not cause the cash flows (depreciation) are added to the net profit.
  • Any increases (decreases) occurred in the items of current assets are subtracted or added.
  • Any increases (decreases) occurred in the articles of short-term assets, which do not require interest payments, are added or subtracted.

Indirect method shows where specifically the profit is materialized, or where real money was invested.

In addition to ease of calculation, the main advantage of using the indirect method in the operational management is the fact that it allows you to establish a correspondence between the financial result and the changes in working capital involved in the main activity.

The use of various forms and methods of the construction of cash flow statements allows doing the analysis of their volume and structure in several aspects. As a result, a user gets a detailed picture about the operational, investment, and financial transactions carried out by the enterprise for the period under review. This in turn enables forming a judgment about the strengths and weaknesses of the company, its current and potential problems.

If you need to prepare a cash flow statement, read the article to learn about various tips on how to write a cash flow statement.

Notion of a Cash Flow Statement and How to Write a Cash Flow Statement

Cash is one of the most limited resources. Therefore, success of business is largely determined by the ability of management to rationally allocate and use it.

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Assignment ID
100000143
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CREATED ON
June 19, 2016
COMPLETED ON
June 20, 2016
Price
$13
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