Statement of cash flow or cash flow statement/ fund flow statement as it was formerly called is a component of the financial statements that explains how a company manages her finances. Questions like how a company makes money, what a company invests in and how projects are financed are explained in the statement of financial statement. It is not enough for a business to report profits, it is essential to ensure that a business have sufficient liquid cash to operate with. Illiquidity in business has seen to the liquidation of profitable businesses in the past.
WHY DO WE NEED STATEMENT OF CASH FLOW?
We need statement of cash-flow for the following reasons:
Legal requirement: it is legally required that every big and medium businesses produce a statement of cash flow to enable users of accounting information make proper analysis of the financial statement. I am sure that you are aware of the fact that no business can operate successfully without observing the provisions of the law. Meeting reporting standards is part of the strategic plans that a business must make in order to succeed in today’s hot business environment.
Determining the capital structure of a business and why overdraft exists even while a company is making profit: it is useful to understand the components of a business’ finance structure. This will help determine the business risk and financial risk of a business. Through the analysis of statement of cash flow, a business can get insight into the reason why overdraft still exist in the company’s statement of financial position (balance sheet as it is formerly called).
Explanation of the reason behind behaviour of certain variables in the financial statement: this is similar to the point explained above. One does not need to be in darkness as to how a company raised cash, how the cash were invested and how the proceeds from business operations were distributed among competing variables.
How funds / cash injected into a business in a given year is used: statement of cash flow consists of three major parts; operating activities, investing activities, and financing activities. This will give clear information of the movement of cash in a business.
Statement of cashflow is used for making forecast: based on the study of cash movement, business managers and executives can make intelligent forecast on a company’s financial profile.
Determining how liquid and solvent a business is: you will agree with me that liquidity is a key factor to the long term success of businesses. A business that is not liquid enough to meet with its immediate cash needs
For valuation purpose: a method of valuation is based the cashflow of a business. The motive of the investor and other variables will have to play a big role in determining the method of business valuation to employ in appraising a business for investment.
To determine working capital requirement: working capital requirement helps determine the capital need of a business and the proportion at which they are needed.
Without the inclusion of statement of cash flow, the importance of accounting would not have been really felt.