The cash flow statement shows the companies cash inflows and outflows over the financial period. It can be classified under three broad heads:
1. Operating cash flows: It includes the cash flows related to the normal day to day functioning of the business. It includes firms’ primary activities of trade. It also includes payment of income taxes.
2. Investing cash flows: It includes the cash flows relating to buying, selling of fixed assets like plant, machinery, buildings, land, etc. It also includes acquisition or sale of securities or segment, investment in other firm. Broadly it can be stated that it includes transactions that deal with acquisition or sale of long term assets.
3. Financing cash flows: It includes the cash flows relating to issuance or retirement of firms’ debt, debentures, shares and dividend paid to shareholders.
One very important thing to note here is that how a transaction is defined depends on the nature of the business the firm does. The most suitable example can be of banks. While issuing or holding long term securities will be an investing activity for most of the firms, but in the case of banking institutions it will be classified as an operating activity.
The firm’s cash flow is quite different from its net income. These differences can arise for at least two reasons:
1. The income statement does not recognize capital expenditures as expenses in the year that the capital goods are paid for. Instead, it spreads those expenses over time in the form of an annual deduction for depreciation.
2. The income statement uses the accrual method of accounting, which means that revenues and expenses are recognized as they are incurred rather than when the cash is received or paid out.
3. Further, the income statement takes into account noncash charges like depreciation, amortisation and write off expenditures which do not result in any actual inflow or outflow. But these transactions are excluded from cash flow statement.
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