Question

Amy and Lester are the owners of The Hardware Store on main street in a large town. Without consulting Amy, Lester hires an accountant to prepare a formal Balance Sheet, Income Statement, and Statement of Cash Flows for The Hardware Store. Amy understands the importance of having a Balance Sheet and Income Statement, but she does not understand the importance of having a Statement of Cash Flows. Amy reasons that examining the Cash account in the General Ledger is sufficient to know where the cash came from and where it was spent. Presume you are the accountant that was hired by Lester. It is your task to explain to Amy the purpose of the Statement of Cash Flows along with its uses and limitations. Please make your initial post your response to Amy.

Answer 1

Refer below the purpose, uses and limitations of Cash Flow Statement

Step-by-step explanation:

Purpose:

A Cash flow statement is an important part of the financial statements published by reporting firms as per the International Accounting Standard (IAS) 7. A Cash flow statement summarizes the movement of cash from opening balance to closing balance of the financial year. It has three main parts, i.e.

1) Cash flow from operations (It comprise of Cash inflows and outflows from operating activities of the organization whereas non-cash items are removed)

2) Cash flow from investments (It comprise of Cash inflows and outflows from investing activities including assets purchased and sold)

3) Cash flow from finance (It comprise of Cash inflows and outflows from financing activities i.e. loans and shares)

Uses/Benefits:

1) Cash flow information is not easy to manipulate as it just reflects cash inflows and cash outflows, it isn’t affected by accounting policies or accruals.

2) The statement of cash flows provides information about all cash inflows and outflows, from all sources.

3) Cash flow information can provide more detail about the quality of the entity’s revenue, for example, whether customers are (in general) paying their bills.

4) It is easier to understand even to a layman not having technical knowledge of accounting and finance.

Limitations:

1) Management may delay paying suppliers to increase the net cash inflows

2) Management may buy goods using leasing arrangements, to avoid paying cash

3) Cash flows also don’t reflect the earnings of the entity, although a company should be cash positive to trade in the short term, if it is doing this at the expense of sales, or is loss making, it may eventually cease trading.