Benefits of Cash Flow Statement and Cash Equivalents, Limitations

The compilation of these Cash Flow Statement Notes makes students exam preparation simpler and organised.

Benefits of Cash Flow Statement and Cash Equivalents

Every business runs with cash and most of the transactions of every business basis on cash. But financial statements like balance sheets and profit and loss mainly focus on financial resources and financial performance leaving cash transactions aside. To fill this gap the concept of a cash flow statement was created. A cash flow statement or Statement of Cash flow mainly focuses on cash transactions and cash equivalents. Even though these statements do not reflect the financial assets of a firm but play a crucial role in the functioning of a business.

Cash and Cash Equivalents

Many of us had a doubt regarding the difference between cash and cash equivalents. Let us know the difference between them and what makes them so different. Cash is nothing but money which means currency and coins.

But when it comes to Cash Equivalents it something which can be readily converted into known amounts of cash. In other words, we can say it as something which has a high liquidating value at a very short-term sale and these include demand deposits, some short-term investments, bank overdrafts, etc.

Benefits of Cash Flow Statement and Cash Equivalents

Cash Flow

According to the dictionary terms, flow means movement, and the flow of cash is termed as cash flow. Generally, cash flow is defined in two types they are cash inflow and cash outflow. The cash transactions which increase the cash amount in the business are cash inflows like receipts from debtors, the sale of fixed assets, etc., and the cash transactions which decrease cash are called outflows like payment of interest on loans.

Benefits of a Cash Flow Statement
The Cash Flow Statement helps in knowing the exact figure of cash inflows and outflows from various operations of the business. It helps in comparing the cash budgets of past assessments with the present to assess the future requirements of the cash. It gives accurate information about the cash-based transactions in the business.

A cash flow statement is majorly used in preparing the cash budget for future needs and helps in knowing the periodical requirement of cash in the business.

It reveals the key changes required for the financial positioning of the business and prioritizes important activities to the management.

It provides information about various investing and financing cash transactions that take place during the year and helps in evaluating the financial structure of the business. The Cash Flow statement helps in identifying the profitability of the business when compared with the ratio analysis.

Limitations of Cash Flow Statement

  • Cash flow statement only confined to money-made transactions leaving the other fund transactions and long-term assets and liabilities.
  • Even though it plays an important role in the business it has limited use when compared with the profit and loss account.
  • These statements don’t disclose the net income from the various operations executed during the course of the business.


Question 1.
Is it necessary to prepare a Cash flow statement along with the financial statements?
As per accounting standard 7, the cash flow statement plays a crucial part in preparing the profit and loss account. Hence preparation of a cash flow statement is required at the end of the annual year along with the financial statements.

Question 2.
What is meant by demand deposits in cash inflows?
Demand deposits are the cash deposits held at a bank or any other financial institution drawn based on the requirement. These are mainly used for fulfilling the short-term cash requirements in the business.