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What are the Sources and Uses of Cash Flow?
In broader terms, the sources of cash flow include the following −
Profitable operations of a firm
Decrease in assets except cash
Proceeds from sale of ordinary shares or preference share issue
Increase in liabilities (including bonds and debentures)
Uses of Cash Flow
Following are some of the uses of Cash Flow −
Loss arising from operations
Increase in assets except cash
Decrease in liabilities including the redemption of bonds and debentures
Redemptions of redeemable preference shares
The statement of changes in cash position is found easily by recording inflows and outflows of cash. The net cash increase is the cash position at the end of a period minus the cash position at the beginning of the period. When the cash position has to be derived from the income statement or comparative balance sheets, the non-cash items must be considered.
For example: Depreciation must be added to net profit when the cash flow is counted just like funds flow. Similarly, gain on the sale of a non-current asset should be subtracted and loss must be added to net profit.
In addition, current asset and liability changes must also be considered whereas judging the cash position of a company.
Changes in Current Assets
When there is an increase in current assets, cash flow from operations is reduced. That means when the ending balance of a period exceeds the balance of the beginning of the period, the net change in cash flow is reduced in nature. The opposite of this is also true. When there is an increase in current assets or when the beginning balance is more than the ending balance in a given period of time, the cash flow is increased.
An increase in the debtor amount indicates that there is a net gain in the cash collection from the customers in the net sales. In case the collection is lesser than the sales, there is an increase in cash flow. In the case of a decrease in cash collection, a net loss is apparent, which means that the amount of sales is lesser than the collection. These details can be obtained from the balance sheets of a firm.
The net position of inventory is adjusted to the cost of goods sold. An increase in inventory shows that the outflow of cash exceeds the value of the cost of goods sold. A decrease in inventory implies that the value of the cost of goods sold exceeds the value of outflows of cash.
An increase in the value of prepaid expenses implies that the cash outflow is more than the exact expense of the company. A decrease in prepaid expenses shows that the cash outflow is less than actual expenses made by the company in a given period of time.
Changes in Current Liabilities
The net cash flow from operations is proportional to the changes in current liabilities. This means that when the current liability decreases, the net cash flow from operations is reduced; whereas in the case when current liability increases, the cash flow also goes up.
There are numerous examples available to prove the above point. Following are some example −
Cash payments to creditors can be less than the purchase figure implied by an increase in the creditors amount. Alternately, a decrease in creditors amount shows that the payment to creditors is more than the purchase figure.
An increase in ‘income in advance’ suggests greater cash inflow than what is suggested in profit and loss account, whereas a decrease in ‘income in advance’ means less of cash inflow than what is suggested in the profit and loss account.
It may therefore be suggested that the cash flow from operations can be obtained by adding the decrease in current assets and increase in current liabilities to net profit and subtracting increase in current assets and current liabilities from net profit. This must be done in addition to the adjustments due to depreciation and loss or gain from sale of non-current assets.
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