Prepare Cash Flow
Introduction
Cash flow is the lifeblood of any business, and understanding how to prepare a cash flow statement is crucial for making informed financial decisions. In this article, we will delve into the world of cash flow and provide a step-by-step guide on how to prepare a cash flow statement using the balance sheets of M/S Tom and Jerry for 2018 and 2019.
What is a Cash Flow Statement?
A cash flow statement is a financial statement that provides a detailed picture of a company's inflows and outflows of cash over a specific period of time. It is a vital tool for businesses, investors, and creditors to assess a company's liquidity, solvency, and financial health.
Components of a Cash Flow Statement
A cash flow statement consists of three main components:
- Cash Flows from Operating Activities: This section includes cash inflows and outflows from a company's core business operations, such as sales, purchases, and collections.
- Cash Flows from Investing Activities: This section includes cash inflows and outflows from a company's investments, such as purchasing or selling assets, investments in other companies, and loans.
- Cash Flows from Financing Activities: This section includes cash inflows and outflows from a company's financing activities, such as borrowing, repaying loans, and issuing or repurchasing shares.
Preparing a Cash Flow Statement
To prepare a cash flow statement, we will use the balance sheets of M/S Tom and Jerry for 2018 and 2019. The balance sheets are as follows:
| Liabilities | 2018 | 2019 | Assets | 2018 | 2019 |
|---|---|---|---|---|---|
| Sundry creditors | 50,000 | 72,000 | Cash at bank | 5,000 | 8,000 |
| Bank overdraft | 20,000 | 30,000 | Cash in hand | 2,000 | 3,000 |
| Accrued expenses | 15,000 | 20,000 | Accounts receivable | 10,000 | 15,000 |
| Inventory | 20,000 | 25,000 | |||
| Property, plant, and equipment | 50,000 | 60,000 | |||
Step 1: Calculate Cash Flows from Operating Activities
To calculate cash flows from operating activities, we need to identify the changes in each account that affects cash flow. We will use the following formula:
Cash flows from operating activities = Net income + Depreciation + Change in accounts receivable + Change in inventory + Change in accounts payable + Change in accrued expenses
Using the balance sheets, we can calculate the changes in each account as follows:
- Net income: Not provided
- Depreciation: Not provided
- Change in accounts receivable: 15,000 - 10,000 = 5,000
- Change in inventory: 25,000 - 20,000 = 5,000
- Change in accounts payable: 72,000 - 50,000 = 22,000
- Change in accrued expenses: 20,000 - 15,000 = 5,000
Step 2: Calculate Cash Flows from Investing Activities
To calculate cash flows from investing activities, we need to identify the changes in each account that affects cash flow. We will use the following formula:
Cash flows from investing activities = Change in property, plant, and equipment + Change in investments
Using the balance sheets, we can calculate the changes in each account as follows:
- Change in property, plant, and equipment: 60,000 - 50,000 = 10,000
- Change in investments: Not provided
Step 3: Calculate Cash Flows from Financing Activities
To calculate cash flows from financing activities, we need to identify the changes in each account that affects cash flow. We will use the following formula:
Cash flows from financing activities = Change in bank overdraft + Change in sundry creditors + Change in accrued expenses
Using the balance sheets, we can calculate the changes in each account as follows:
- Change in bank overdraft: 30,000 - 20,000 = 10,000
- Change in sundry creditors: 72,000 - 50,000 = 22,000
- Change in accrued expenses: 20,000 - 15,000 = 5,000
Cash Flow Statement
Using the calculations above, we can prepare a cash flow statement for M/S Tom and Jerry for 2018 and 2019 as follows:
| Cash Flows | 2018 | 2019 |
|---|---|---|
| Cash flows from operating activities | ||
| Net income | ||
| Depreciation | ||
| Change in accounts receivable | 5,000 | 5,000 |
| Change in inventory | 5,000 | 5,000 |
| Change in accounts payable | 22,000 | 22,000 |
| Change in accrued expenses | 5,000 | 5,000 |
| Total | ||
| Cash flows from investing activities | ||
| Change in property, plant, and equipment | 10,000 | 10,000 |
| Change in investments | ||
| Total | ||
| Cash flows from financing activities | ||
| Change in bank overdraft | 10,000 | 10,000 |
| Change in sundry creditors | 22,000 | 22,000 |
| Change in accrued expenses | 5,000 | 5,000 |
| Total | ||
| Net cash flow |
Conclusion
Preparing a cash flow statement is a crucial step in understanding a company's financial health. By following the steps outlined above, we can prepare a cash flow statement that provides a detailed picture of a company's inflows and outflows of cash over a specific period of time. This statement is essential for businesses, investors, and creditors to assess a company's liquidity, solvency, and financial health.
Recommendations
Based on the cash flow statement prepared above, we can make the following recommendations:
- M/S Tom and Jerry should focus on improving their cash flow from operating activities by reducing their accounts receivable and inventory levels.
- The company should also consider investing in new equipment and technology to improve their efficiency and reduce costs.
- Finally, the company should review their financing activities and consider alternative financing options to reduce their reliance on bank overdrafts and sundry creditors.
Limitations
This article has several limitations. Firstly, the balance sheets used are hypothetical and may not reflect the actual financial situation of M/S Tom and Jerry. Secondly, the cash flow statement prepared above is a simplified example and may not reflect the complexities of a real-world cash flow statement. Finally, the recommendations made above are based on a limited analysis and may not be applicable to all businesses.
Future Research
Introduction
Preparing a cash flow statement is a crucial step in understanding a company's financial health. However, many business owners and financial professionals may have questions about the process and what it entails. In this article, we will answer some of the most frequently asked questions about cash flow and provide guidance on how to prepare a cash flow statement.
Q: What is a cash flow statement?
A: A cash flow statement is a financial statement that provides a detailed picture of a company's inflows and outflows of cash over a specific period of time. It is a vital tool for businesses, investors, and creditors to assess a company's liquidity, solvency, and financial health.
Q: Why is a cash flow statement important?
A: A cash flow statement is important because it helps businesses and investors understand a company's ability to generate cash and meet its financial obligations. It also helps identify areas where a company can improve its cash flow and make informed decisions about investments and financing.
Q: What are the three main components of a cash flow statement?
A: The three main components of a cash flow statement are:
- Cash Flows from Operating Activities: This section includes cash inflows and outflows from a company's core business operations, such as sales, purchases, and collections.
- Cash Flows from Investing Activities: This section includes cash inflows and outflows from a company's investments, such as purchasing or selling assets, investments in other companies, and loans.
- Cash Flows from Financing Activities: This section includes cash inflows and outflows from a company's financing activities, such as borrowing, repaying loans, and issuing or repurchasing shares.
Q: How do I prepare a cash flow statement?
A: To prepare a cash flow statement, you will need to gather financial data from your company's balance sheet, income statement, and other financial records. You will then use this data to calculate the cash flows from operating, investing, and financing activities.
Q: What are some common mistakes to avoid when preparing a cash flow statement?
A: Some common mistakes to avoid when preparing a cash flow statement include:
- Failing to account for non-cash items, such as depreciation and amortization
- Failing to account for changes in accounts receivable and payable
- Failing to account for investments and financing activities
- Using incorrect or incomplete financial data
Q: How often should I prepare a cash flow statement?
A: You should prepare a cash flow statement at least quarterly, but ideally monthly. This will help you stay on top of your company's cash flow and make informed decisions about investments and financing.
Q: What are some benefits of preparing a cash flow statement?
A: Some benefits of preparing a cash flow statement include:
- Improved cash flow management
- Increased financial transparency and accountability
- Better decision-making about investments and financing
- Improved relationships with investors and creditors
Q: Can I use a cash flow statement to predict future cash flows?
A: Yes, you can use a cash flow statement to predict future cash flows. By analyzing your company's historical cash flow data and making adjustments for future changes, you can create a forecast of your company's future cash flows.
Q: What are some common cash flow ratios that I should be aware of?
A: Some common cash flow ratios that you should be aware of include:
- Cash Flow Margin: This ratio measures a company's ability to generate cash from its sales.
- Cash Flow Return on Investment (CFROI): This ratio measures a company's ability to generate cash from its investments.
- Debt Service Coverage Ratio (DSCR): This ratio measures a company's ability to meet its debt obligations.
Conclusion
Preparing a cash flow statement is a crucial step in understanding a company's financial health. By following the steps outlined above and avoiding common mistakes, you can create a cash flow statement that provides a detailed picture of your company's inflows and outflows of cash. Remember to prepare a cash flow statement regularly and use it to make informed decisions about investments and financing.