Creating Cash Flow Statement Part - I

Next in the series of Annual financial statements is the Cash flow statement. First of all, let us understand why any business needs a cash flow statement?

I don't want to confuse you here with business jargon. But this can be understood by an example.

Say we run a company X which manufacture toys. For that, it procures raw materials from suppliers and converts them into toys (finished goods). Not all toys manufactured toys sells in a single day. Therefore we will have to store the toys and hence inventory evolves. Also, not all buyers give you payment at once. Buyers take time to give you cash but the bill is generated on the day of the sale itself because GST is filed based on bill date and not the amount received date. That's their business model.

There are two types of expense cash and non-cash expense. To connect with the above example, company X bought machines worth Rs.10 lakhs with a lifespan of 10 years. This essentially means we need to replace the machine after 10 years. This is an expense but actually happens after 10 years. But all of a sudden Rs.10 lakhs expense at the 10th year may be a burden. So we split or divide Rs.10 lakhs over the period of 10 years. So each year we set aside 1 lakh for the future expense. This is called non-cash expense.

We can give business jargon to each process in the above business model.

When company X pays supplier after 30 days - Credit and supplier is called Creditors

Not all finished goods sold a single day - Inventory and it takes time to sell say(15 days on average)

When buyer gives you payment after 60 days - Credit and buyer is called Debtors

GST is filed based on bill date and not cash received date - Accrual based accounting

Setting aside machine after 10 years - Depreciation and it is a non-cash expense.

Stake holder Supplier --> Company X(time to sell) --> Buyer

Credit period 30 days 15 days 60 days

Cash value Rs.1 lakh Rs.50000(Unsold) Rs.2 lakhs

Total days = 30 + 15 + 60 =105 days - Working capital cycle

I can interpret from above that it takes 75 days(15 + 60) to realise the cash of finished goods but I need to pay my supplier of raw materials on the 30th day. This is a cash flow problem. This can be solved by working capital loans such as CC/OD(i.e Cash Credit and OverDraft loans by banks).Note: This is an oversimplified version of Working capital/cycle

Need for Cash flow statement

Because whatever the Profit & Loss statement gives you a profit or loss will not be reflected in cash in hand. The main reason is the credit cycle and depreciation. There are non-cash expenses like depreciation and credit cycle mismatch between creditors and debtors.

Profit and Loss Statement

Cash Flow Statement

Accrual basis(Bill date)

Cash basis

Provides information about profitability and owner capital

Provides information about working capital management and liquidity i.e how fast businesses can arrange cash

To conclude, Profit & Loss are concerned with Revenue and Expenses whereas Cash Flow is concerned with Cash inflow and Cash Outflow during the period in consideration.

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Disclaimer: This article is me speaking to me through this blog! Short Intro: If you want to innovate in a particular field, you need to understand how things work in the first place. Innovation is a