Cash Flow Analysis/Statement: Advantages and disadvantages

Meaning and Definition of Cash Flow Statement

Cash is a vital element of any business entity, as it plays a crucial role throughout the entire lifetime of a business enterprises. Cash for a business has been aptly compared with the blood for a human body. Cash is required to meet day-to-day requirements for running the business and for making payments to suppliers.

According to Indian Accounting Standars (AS-3)__ Cash flow means inflow and outflow of cash and cash equivalents. Cash comprises of cash in hand and demand deposits with banks. Cash equivalents are short-term,highly liquid investments which are readily convertible into cash

Cash flow statement may be defined as a statement,which depicts the changes in financial position of a business organization due to inflows and outflows of cash. Analysis of such inflow and outflows is necessitated for short-range business activities.

Advantages of Cash Flow Statement

  1. It facilitates measurement of the business enterprise’s ability to meet its fixed charges.
  2. It is useful in bringing to the forefront the business enterprises’s status with regard to its liquidity and solvency during adverse conditions.
  3. It is helpful in assessing the changes in cash position between profit&loss accounts and balance sheet items of two consecutive accounting periods.
  4. It can be used for appraisal of various capital investment projects just to determine their viability and profitability.
  5. The projected cash flow statement helps the management to,prepare cash budget.
  6. The financial plan and policies are prepared with the help of detailed information of cash flow analysis in the years to come.

Disadvantages of cash Flow Statement

  1. Limited Use: Cash flow statement has very limited use in isolation. Only when it is accompanied by other financial statements like balance sheet and profit and loss account, it provides some meaningful and useful results.
  2. Historical in nature: Preparation of cash low statement involves rearranging other financial statements, viz. balance sheet and profit & loss account,which contain past data and are historical in nature.
  3. Ignoring the Accrual Concept: Accrual concept one of the basic accounting concepts, is totally ignored while preparing cash flow statement.
  4. Not a substitute for an income statement.