The preparation and analysis of a cash flow statement are essential components of financial reporting and analysis, providing insights into an entity’s liquidity, solvency, and financial flexibility by presenting the cash inflows and outflows from operating, investing, and financing activities. The cash flow statement complements the income statement and balance sheet, offering a comprehensive view of an entity’s cash management practices and financial performance. Here’s an overview of the preparation of a cash flow statement and its analysis:
Preparation of Cash Flow Statement:
1. Operating Activities:
- Direct Method: Prepare the operating activities section using the direct method by listing major categories of gross cash receipts and gross cash payments, such as cash received from customers, cash paid to suppliers, employees, and other operating expenses.
- Indirect Method: Alternatively, prepare the operating activities section using the indirect method by adjusting net income for non-cash items, changes in working capital accounts, and other reconciling items to determine the net cash provided by or used in operating activities.
2. Investing Activities:
- Identify and list the cash inflows and outflows related to investing activities, such as cash received from the sale of assets and cash paid for the acquisition of assets, investments, or other capital expenditures.
3. Financing Activities:
- Identify and list the cash inflows and outflows related to financing activities, such as cash received from the issuance of equity or debt instruments and cash paid for the repayment or return of funds to shareholders or creditors.
4. Net Cash Flow:
- Calculate the net increase or decrease in cash and cash equivalents by aggregating the net cash flows from operating, investing, and financing activities to reconcile the beginning and ending cash and cash equivalents balance.
Analysis of Cash Flow Statement:
1. Liquidity Analysis:
- Assess the liquidity position of the entity by analyzing the net cash provided by or used in operating activities, evaluating the ability to generate positive cash flows from core business operations to meet short-term obligations and fund future growth opportunities.
2. Investing Activities Analysis:
- Evaluate the investing activities section to assess the capital allocation and investment strategies of the entity, identifying significant investments in property, plant, equipment, or other long-term assets and analyzing the returns generated from investing activities.
3. Financing Activities Analysis:
- Analyze the financing activities section to assess the capital structure and financing decisions of the entity, evaluating the reliance on external financing sources, monitoring the repayment of debt obligations, and assessing the return of funds to shareholders or investors.
4. Operating Performance Analysis:
- Analyze the operating activities section to assess the operating performance and cash flow generation capabilities of the entity, comparing the net cash provided by or used in operating activities to the net income and identifying any significant reconciling items or adjustments affecting cash flows.
5. Free Cash Flow Analysis:
- Calculate and analyze the free cash flow by adjusting the net cash provided by or used in operating activities for capital expenditures and dividends, assessing the ability to generate excess cash flows available for reinvestment, debt reduction, shareholder returns, or other strategic initiatives.
6. Trend Analysis and Variance Analysis:
- Conduct trend analysis by comparing the cash flow statement over multiple periods to identify trends, patterns, or changes in cash flow activities and assess the consistency, volatility, or growth in cash flows.
- Perform variance analysis by comparing the actual cash flows to budgeted or forecasted amounts, evaluating the accuracy of cash flow projections, and identifying any significant variances or deviations requiring further analysis or explanation.
 the preparation and analysis of a cash flow statement involve organizing and presenting the cash inflows and outflows from operating, investing, and financing activities, assessing the liquidity, solvency, operating performance, capital allocation, and financial flexibility of the entity, and supporting informed decision-making, planning, and control to achieve strategic and operational objectives. By effectively preparing and analyzing the cash flow statement, stakeholders can gain valuable insights into the cash management practices, financial performance, and sustainability of the entity in a competitive and dynamic business environment.