The Cash flow statement represents the increased or decreased position of cash and cash equivalents in a business. In a way, it is useful in assessing the company’s ability to meet its short-term obligations. Cash equivalent means highly liquid current assets which can be readily converted into cash without any loss in value or time. For example, inventories in a restaurant will be exhausted on the daily basis and at the most, some provisions may not last long for over a month. Such items which will be quickly converted into cash can be treated as the cash equivalent.
Let us illustrate cash flow statement with an example of a Rice Trader. A trader buys 100 kilos of ‘Rice’ at the rate of Rs.50/= per Kilo and sells it at Rs.55/- per Kilo and makes the profit of Rs.5/= per Kilo. Here we will be able to determine his total profit is Rs.500/- as he has sold 100 kilos of rice with a profit margin of Rs.5/- per kilo. In this case, the profit remains same, but the cash flow may vary depending upon the method of his business decision such as
(a). To buy and sell for “Cash”,(b). To buy on cash and sell on credit, (c). To buy on credit and sell on Cash (d). To buy on credit and sell on credit.
In the above illustrations, we have understood that buying the rice on cash payment and selling them on credit results in negative cash inflow as the trader does not receive money immediately against rice sold. Buying rice on credit and selling them on cash will have the positive effect on cash flow as the trader receives cash on selling rice for which he is yet to make payment.
Let us go for one more situation. Suppose the trader has sold only 50 kilos of rice in the first week, out of 100 kilos purchased by him. The cash inflow for the first week is only Rs.2750.00 (=55×50).In this case, the inflow of cash during the week is Rs.2750.00 which is less than the outflow amount of Rs.5000.00. When inflow of cash is less than the outflow of cash it would reduce the working capital which affects the trader’s ability to meet his short-term obligations.However if the trader was able to sell 100 kilos of rice during the same period, cash inflow would have been Rs.5500.00=(55×100). In this case,the inflow of cash during the week is Rs.5500.00 which is more than the outflow amount of Rs.5000.00. Due to the availability of additional cash of Rs.500.00 by way of profit the working capital is increased by Rs.500.00 and therefore the trader is more comfortable in meeting his short-term obligations.
Effect of cash flow in inventory holding over a period of time:
(a). In the first year, a trader has purchased 1000 kilos of Rice @ Rs.50/Kg and sold 900 kilos @Rs.55.00.(Inventory holding at the close of the year is 100 Kilos)
(b). In the second year, he purchased 1000 kilos of rice @ Rs.50.00 and sold 1050 kilos @Rs.55.00.( Inventory holding at the close of the year is 50 Kilos)
(c). In the third year, he purchased 1050 kilos of rice @ Rs.50.00 and sold 1000 kilos @ Rs.55.00.(Inventory holding at the close of the year is 100 Kilos)
(d).For computation purpose, it is presumed that there is no change in the purchase price and selling price of rice for the entire period of three years.
Computation of Cash flow for the above example:
|1st Year Rs.||2nd Year
|3rd Year Rs.|
|1. Receipts (sale of rice at Rs.55 per kilo.)||49500||57750||55000|
|1. Payments (Purchase of rice for cash@50)||50000||50000||52500|
|c. Net Cash flow||(-) 500||(+)7750||(+)2500|
|1. Working capital at the beginning of the year||50000||49500||57250|
|1. Working capital at the close of the year(c+d)||49500||57250||59750|
Loan under cash budget method:The request for financial assistance from business enterprises dealing in seasonal products like sugar, tea, construction activities, film industries, order based activities etc. are facilitated by the banks through Cash Budget financing plans.