Cost Analysis in Financial Accounting and Managements For BCA | BBA | MBA | MCA

Table of Contents ▼

1. Meaning of Cash Flow Statement
2. Importance of Cash Flow Statements
3. Objectives of Cash Flow Statement
4. How Cash Flow Statements Help in Financial Planning
5. Uses of Cash Flow Statement
6. How to Prepare a Cash Flow Statement
7. Common Mistakes to Avoid When Preparing a Cash Flow Statement
8. Difference Between Cash Flow and Fund Flow
9. Calculation of Cash From Operations
10. Format of Cash Flow Statement
11. FAQs

Meaning of Cash Flow Statement | Cost Analysis 

Meaning of Cash Flow Statement

A cash flow statement is a financial document that shows how cash moves in and out of a business during a specific period. It helps track the actual cash available to meet short-term obligations and manage day-to-day operations. The statement divides cash flows into three categories: operating activities, investing activities, and financing activities.

What is a Cash Flow Statement?

A cash flow statement is like a diary of cash transactions. It records all the cash that comes into the business (inflows) and all the cash that goes out (outflows). This statement helps businesses understand where their money is coming from and where it's going. For example, if a small business sells goods worth ₹1,00,000 but receives only ₹70,000 in cash because some customers bought on credit, the cash flow statement will reflect the ₹70,000 received.

Categories in a Cash Flow Statement:

1. Operating Activities:

• This section includes cash transactions related to the core business operations. It shows cash generated or used in regular business activities like sales, payments to suppliers, and wages.
• Example: A bakery sells cakes and receives ₹50,000 in cash (inflow) and pays ₹30,000 for ingredients and salaries (outflow).

2.  Investing Activities:

• This section covers cash transactions for buying and selling assets like machinery, equipment, or investments. It shows cash used for long-term growth.
• Example: The bakery buys a new oven for ₹10,000 (outflow) and sells old equipment for ₹5,000 (inflow).

3. Financing Activities:

• This section includes cash transactions related to funding the business, such as loans, issuing shares, or paying dividends.
• Example: The bakery takes a loan of ₹20,000 (inflow) and repays ₹5,000 of an existing loan (outflow).

Importance of Cash Flow Statements in Financial Analysis

1. Liquidity Management:

A cash flow statement helps businesses manage liquidity by showing how much cash is available to pay bills and invest in opportunities. For instance, if a business sees that most of its cash outflow happens at the start of the month, it can plan accordingly to ensure enough cash is available.

2. Performance Evaluation:

Investors and analysts use cash flow statements to evaluate a company's performance. Positive cash flow from operating activities indicates a healthy, profit-generating business. For example, if two companies both show profits but one has negative cash flow due to high receivables, it signals potential trouble in collecting payments.

3. Financial Planning:

Businesses use cash flow statements to plan for future financial needs. By understanding past cash flow trends, a business can forecast future cash needs and avoid shortfalls. For example, if a business plans to expand, the cash flow statement will help determine if there is enough cash or if external funding is needed.

4. Risk Management:

Cash flow statements help identify risks early. If a business notices decreasing cash flows, it can take steps to cut costs or improve collections. For instance, if a retail shop sees cash outflows rising due to high rent, it might negotiate a better lease or look for a cheaper location.

A cash flow statement is essential for understanding the cash health of a business. It categorizes cash movements into operating, investing, and financing activities, providing a clear picture of how cash flows in and out. This helps in managing liquidity, evaluating performance, planning finances, and mitigating risks, ensuring the business stays financially healthy.

Objectives of Cash Flow Statement

A cash flow statement is an essential financial report that shows how cash moves in and out of a business. It helps understand the liquidity and financial health of the company. Here are the key objectives of preparing a cash flow statement:

Key Objectives of Preparing a Cash Flow Statement

1. Understand Cash Position:

The primary objective is to show the actual cash position of the business. By tracking cash inflows and outflows, businesses can see how much cash they have at any given time. For example, if a small shop owner wants to know if they have enough cash to buy new stock, the cash flow statement provides that information.

2. Evaluate Financial Performance:

It helps in assessing how well the business is performing financially. The statement highlights the company's ability to generate cash from its operations. For instance, a manufacturing company can use the cash flow statement to see if its core operations are generating sufficient cash.

4. Plan for Future Cash Needs:

The cash flow statement helps in planning for future cash requirements. By analyzing past cash flows, businesses can predict future cash needs and plan accordingly. For example, if a business sees a trend of higher cash outflows during certain months, it can prepare to have extra cash on hand during those times.

5. Make Investment Decisions:

It provides crucial information for making investment decisions. Investors and creditors look at the cash flow statement to determine if the business has enough cash to pay dividends or repay loans. For example, an investor considering putting money into a startup will check the cash flow statement to ensure the startup can manage its finances.

6. Monitor Cash Management:

It helps in monitoring how effectively the business is managing its cash. For example, a retailer can use the statement to check if they are collecting payments from customers on time and paying suppliers promptly.

How Cash Flow Statements Help in Financial Planning

1. Ensuring Liquidity:

A cash flow statement helps businesses ensure they have enough liquidity to meet short-term obligations. For example, a restaurant owner can use the statement to make sure there is enough cash to pay for daily supplies and staff salaries.

2. Budgeting and Forecasting:

It helps in creating accurate budgets and forecasts. By understanding past cash flow patterns, businesses can make realistic future projections. For instance, a clothing store can forecast cash flows for the next season based on previous sales trends.

3. Identifying Financial Issues:

The statement can highlight potential financial problems before they become critical. For example, if a business sees that cash outflows consistently exceed inflows, it indicates a cash management problem that needs immediate attention.

4. Supporting Loan Applications:

Lenders often require a cash flow statement when considering loan applications. It shows the business’s ability to generate cash and repay loans. For example, a small business applying for a loan to expand operations will need to provide a cash flow statement to demonstrate its repayment capability.

5. Guiding Investment in Assets:

It helps in deciding when to invest in new assets or equipment. For example, a farmer can use the cash flow statement to determine the best time to purchase new machinery, ensuring enough cash is available to cover the cost.

Uses of Cash Flow Statement

Practical Uses of Cash Flow Statements for Businesses:

a. Understanding Cash Position:

• Example: Imagine you run a small grocery store. At the end of the month, you check your cash flow statement. It shows all the cash you received from sales and all the cash you spent on buying goods, paying rent, and other expenses. This helps you see if you have enough cash to keep the store running smoothly.

b. Planning for Future Expenses:

• Example: Suppose your store is planning to buy a new refrigerator next month. By looking at your cash flow statement, you can determine if you have enough cash saved or if you need to cut down on other expenses to afford it.

c. Managing Surplus Cash:

• Example: If your store has extra cash, the cash flow statement helps you decide how to use it best. You might reinvest it in the business, like buying more stock, or save it for future needs.

d. Tracking Cash Sources:

• Example: Your grocery store receives cash from different sources like sales, loans, and owner investments. The cash flow statement shows which source contributed the most, helping you understand your main revenue streams.

e. Identifying Cash Shortages:

• Example: If your store frequently runs out of cash before the month ends, the cash flow statement can help identify where you’re overspending, allowing you to adjust your budget.

How Investors Use Cash Flow Statements for Decision-Making:

a. Evaluating Financial Health:

• Example: An investor looking to invest in your grocery store will check your cash flow statement. A positive cash flow indicates that your store is generating enough cash to cover its expenses, which is a good sign of financial health.

b. Assessing Liquidity:

• Example: If your cash flow statement shows that your store has sufficient cash to meet short-term obligations, investors see it as a low-risk investment because you can easily pay off debts and other immediate expenses.

c. Predicting Future Performance:

• Example: An investor reviews your cash flow statement over several months. Consistent positive cash flow suggests that your store is likely to perform well in the future, making it an attractive investment opportunity.

d. Making Comparison with Competitors:

• Example: If an investor is considering multiple grocery stores to invest in, they will compare the cash flow statements of each. The store with stronger and more stable cash flow will be the more attractive option.

e. Understanding Cash from Operations:

• Example: An investor will look at how much cash your store generates from its main operations (sales of groceries). If most of the cash is coming from your core business activities, it shows that your store is doing well in its primary business area.

A cash flow statement is a crucial financial tool for both business owners and investors. For businesses, it helps manage cash, plan for future expenses, and identify cash flow problems. For investors, it provides insights into a company’s financial health, liquidity, and future performance potential. By understanding and utilizing cash flow statements, businesses can ensure better financial management, and investors can make more informed investment decisions.

How to Prepare a Cash Flow Statement

Step-by-Step Guide to Preparing a Cash Flow Statement

1. Understand the Basics:

• A cash flow statement shows how cash moves in and out of a business during a specific period. It has three main sections: operating activities, investing activities, and financing activities.

2. Gather Necessary Information:

• Collect financial data such as the income statement, balance sheet, and other relevant documents for the period you want to analyze.

3. Calculate Cash Flow from Operating Activities:

• Start with the net profit from the income statement.
• Adjust for non-cash items like depreciation and amortization.
• Include changes in working capital, such as accounts receivable, inventory, and accounts payable.
• Example:
• Net profit: ₹50,000
• Add: Depreciation: ₹10,000
• Increase in accounts receivable: ₹5,000 (subtract)
• Decrease in inventory: ₹3,000 (add)
• Increase in accounts payable: ₹2,000 (add)
• Cash flow from operating activities: ₹60,000

4. Calculate Cash Flow from Investing Activities:

• Record cash spent on purchasing assets like equipment or property.
• Include cash received from selling these assets.
• Example:
• Purchased machinery: ₹20,000 (outflow)
• Sold old equipment: ₹5,000 (inflow)
• Cash flow from investing activities: ₹15,000 (outflow)

5. Calculate Cash Flow from Financing Activities:

• Record cash inflows from issuing shares or taking loans.
• Include cash outflows for repaying loans or paying dividends.
• Example:
• Loan received: ₹30,000 (inflow)
• Dividends paid: ₹10,000 (outflow)
• Cash flow from financing activities: ₹20,000

6. Summarize the Cash Flows:

Add the cash flows from all three activities to find the net increase or decrease in cash.

• Example:
• Cash flow from operating activities: ₹60,000
• Cash flow from investing activities: ₹15,000 (outflow)
• Cash flow from financing activities: ₹20,000
• Net increase in cash: ₹60,000 - ₹15,000 + ₹20,000 = ₹65,000

7. Prepare the Final Statement:

• List the cash flows under each section (operating, investing, financing).
• Show the beginning and ending cash balance.
• Example:
• Beginning cash balance: ₹10,000
• Net increase in cash: ₹65,000
• Ending cash balance: ₹75,000

Common Mistakes to Avoid When Preparing a Cash Flow Statement

1. Ignoring Non-Cash Items:

• Don't forget to adjust for non-cash expenses like depreciation. These do not affect cash flow directly but are crucial for accurate calculations.

2. Confusing Inflows and Outflows:

• Clearly distinguish between cash inflows (money coming in) and outflows (money going out). Misclassifying these can lead to incorrect results.

3. Overlooking Changes in Working Capital:

• Changes in accounts receivable, inventory, and accounts payable impact cash flow. Ensure you account for these changes accurately.

4. Mixing Up Different Activities:

• Keep operating, investing, and financing activities separate. Mixing them can make the statement confusing and incorrect.

5. Not Updating Regularly:

• Regularly update the cash flow statement to reflect current financial conditions. An outdated statement can mislead decision-making.

6. Forgetting the Opening and Closing Balances:

• Always include the beginning and ending cash balances to provide a complete picture of cash flow.
• By following these steps and avoiding common mistakes, you can prepare an accurate cash flow statement that provides valuable insights into your business’s financial health.

Difference Between Cash Flow and Fund Flow Statements

Understanding Cash Flow vs. Fund Flow Statements

Cash Flow Statement:

A cash flow statement tracks the flow of cash in and out of a business over a specific period. It shows how much cash is coming in (inflows) and how much is going out (outflows). This statement helps understand the liquidity position of a company, meaning how much cash is available to meet immediate expenses.

Fund Flow Statement:

A fund flow statement, on the other hand, looks at the changes in the financial position of a company between two balance sheet dates. It highlights where funds come from (sources) and where they are used (applications). This statement helps understand the financial health of a company over a longer period.

Key Differences and Their Implications on Financial Reporting

Purpose:

• Cash Flow Statement: Focuses on the liquidity of the company. It shows how well the company can generate cash to pay bills, salaries, and other expenses.
• Fund Flow Statement: Focuses on the overall financial stability of the company. It shows how funds are sourced and used over time.

Time Frame:

• Cash Flow Statement: Covers a specific period, such as a month, quarter, or year.
• Fund Flow Statement: Compares the financial position between two specific dates, such as from the end of one financial year to the end of the next.

Components:

• Cash Flow Statement: Has three main components:
1. Operating Activities: Cash generated from core business operations (e.g., cash sales of ₹1,00,000).
2. Investing Activities: Cash used for investment in assets (e.g., buying machinery for ₹50,000).
3. Financing Activities: Cash from or used in borrowing or repaying loans (e.g., taking a loan of ₹30,000).

• Fund Flow Statement: Focuses on:
1. Sources of Funds: Where the funds come from (e.g., issuing shares, selling an old asset).
2. Applications of Funds: Where the funds are used (e.g., buying a new building, repaying loans).

Details:

• Cash Flow Statement: Deals only with actual cash transactions. It does not include credit sales or purchases.
• Fund Flow Statement: Includes all financial changes, including credit transactions, non-cash items like depreciation, and changes in working capital.

Implications:

• Cash Flow Statement: Helps in assessing the company's ability to generate cash and manage short-term financial obligations. It is crucial for daily operations.
• Fund Flow Statement: Helps in understanding the long-term financial strategy and stability. It is useful for investors and management to make strategic decisions.

Example for Better Understanding:

Let's say a small business, XYZ Ltd., had the following transactions:

• Sold goods worth ₹1,00,000 in cash.
• Bought machinery for ₹50,000.
• Took a loan of ₹30,000.
• Issued shares worth ₹20,000.
• Repaid a loan of ₹10,000.

Cash Flow Statement:

• Operating Activities: ₹1,00,000 (cash sales)
• Investing Activities: -₹50,000 (purchase of machinery)
• Financing Activities: ₹20,000 (issued shares) + ₹30,000 (new loan) - ₹10,000 (loan repayment)
• Net Cash Flow: ₹90,000 (total inflows) - ₹60,000 (total outflows) = ₹30,000 net increase in cash

Fund Flow Statement:

• Sources of Funds: ₹20,000 (issued shares) + ₹30,000 (new loan)
• Applications of Funds: ₹50,000 (purchase of machinery) + ₹10,000 (loan repayment)
• Net Change in Working Capital: This shows how these funds affect the overall financial position of the business.

Understanding these differences helps in better financial planning and decision-making. The cash flow statement provides a snapshot of liquidity, while the fund flow statement offers a broader view of financial health and stability. Both are crucial for different aspects of financial management.

Calculation of Cash from Operations (Problems)

How to Calculate Cash from Operations: Examples and Problems

Introduction:

Cash from operations, also known as operating cash flow, is the amount of cash generated by a company's regular business activities. It is an important metric because it shows whether a company can generate enough cash to maintain and grow its operations. Here's how you can calculate cash from operations in simple terms, with examples and problems.

Steps to Calculate Cash from Operations:

1. Start with Net Income:

• Net income is the profit a company makes after all expenses, including taxes and interest, are subtracted from total revenue. This is the starting point for calculating cash from operations.

2. Add Non-Cash Expenses:

• Non-cash expenses like depreciation and amortization reduce net income but do not involve actual cash outflows. Add these expenses back to net income.

3. Adjust for Changes in Working Capital:

• Working capital consists of current assets (like inventory and receivables) minus current liabilities (like payables). Changes in working capital affect cash flow. For example, an increase in accounts receivable means more sales on credit and less cash collected, so we subtract this increase from net income.

Example 1: Calculate Cash from Operations 

Let's say ABC Ltd. has the following data:

• Net Income: ₹50,000
• Depreciation Expense: ₹10,000
• Increase in Accounts Receivable: ₹5,000
• Increase in Accounts Payable: ₹2,000

Steps:

• Start with net income: ₹50,000
• Add non-cash expenses (depreciation): ₹50,000 + ₹10,000 = ₹60,000
• Subtract increase in accounts receivable: ₹60,000 - ₹5,000 = ₹55,000
• Add increase in accounts payable: ₹55,000 + ₹2,000 = ₹57,000
• Cash from Operations: ₹57,000

Example 2: Calculate Cash from Operations

Consider XYZ Ltd. with these figures:

• Net Income: ₹75,000
• Depreciation Expense: ₹15,000
• Decrease in Inventory: ₹8,000
• Decrease in Accounts Payable: ₹3,000

Steps:

• Start with net income: ₹75,000
• Add non-cash expenses (depreciation): ₹75,000 + ₹15,000 = ₹90,000
• Add decrease in inventory: ₹90,000 + ₹8,000 = ₹98,000
• Subtract decrease in accounts payable: ₹98,000 - ₹3,000 = ₹95,000
• Cash from Operations: ₹95,000

Cash Flow Statement Problems and Solutions

Problem 1: Calculating Net Cash Flow

Scenario:

Imagine you run a small bakery. In January month, your bakery had the following transactions:

• Sales Revenue: ₹50,000
• Purchase of Ingredients: ₹15,000
• Rent Payment: ₹10,000
• Employee Salaries: ₹8,000
• Utility Bills: ₹2,000

Objective:

Calculate the net cash flow for January.

Solution:

1. Total Inflows:
• Sales Revenue: ₹50,000
2. Total Outflows:
• Purchase of Ingredients: ₹15,000
• Rent Payment: ₹10,000
• Employee Salaries: ₹8,000
• Utility Bills: ₹2,000
• Total Outflows: ₹15,000 + ₹10,000 + ₹8,000 + ₹2,000 = ₹35,000
3. Net Cash Flow:
• Net Cash Flow = Total Inflows - Total Outflows
• Net Cash Flow = ₹50,000 - ₹35,000 = ₹15,000

Your bakery has a positive net cash flow of ₹15,000 for January.

Problem 2: Cash Flow from Operating Activities

Scenario:

You own a small clothing store. During February, you had the following cash activities:

• Cash Sales: ₹40,000
• Credit Sales: ₹20,000 (customers will pay later)
• Payments to Suppliers: ₹12,000
• Rent: ₹5,000
• Advertising: ₹3,000
• Salary Payments: ₹10,000

Objective:

Calculate the cash flow from operating activities.

Solution:

1. Cash Inflows from Operating Activities:
• Cash Sales: ₹40,000
2. Cash Outflows from Operating Activities:
• Payments to Suppliers: ₹12,000
• Rent: ₹5,000
• Advertising: ₹3,000
• Salary Payments: ₹10,000
• Total Outflows: ₹12,000 + ₹5,000 + ₹3,000 + ₹10,000 = ₹30,000
3. Net Cash Flow from Operating Activities:
• Net Cash Flow from Operating Activities = Cash Inflows - Cash Outflows
• Net Cash Flow from Operating Activities = ₹40,000 - ₹30,000 = ₹10,000

Your clothing store has a positive cash flow from operating activities of ₹10,000 for February.

Problem 3: Impact of Non-Operating Activities on Cash Flow

Scenario:

You are running a small electronics shop. In March, apart from regular business activities, you also had these transactions:

• Interest Received from Bank: ₹2,000
• Purchase of New Equipment: ₹5,000
• Loan Repayment: ₹3,000

Objective:

Calculate the overall cash flow, including non-operating activities.

Solution:

1. Cash Inflows from Non-Operating Activities:
• Interest Received: ₹2,000
2. Cash Outflows from Non-Operating Activities:
• Purchase of New Equipment: ₹5,000
• Loan Repayment: ₹3,000
• Total Outflows: ₹5,000 + ₹3,000 = ₹8,000
3. Net Cash Flow from Non-Operating Activities:
• Net Cash Flow from Non-Operating Activities = Cash Inflows - Cash Outflows
• Net Cash Flow from Non-Operating Activities = ₹2,000 - ₹8,000 = -₹6,000 (negative cash flow)
4. Combining Operating and Non-Operating Activities:
• Assume net cash flow from operating activities is ₹10,000 (as calculated in the previous example)
• Overall Net Cash Flow = Net Cash Flow from Operating Activities + Net Cash Flow from Non-Operating Activities
• Overall Net Cash Flow = ₹10,000 - ₹6,000 = ₹4,000

Your electronics shop has an overall positive cash flow of ₹4,000 for March.

Format of Cash Flow Statement

Particulars		Amount (₹)
Cash Flow from Operating Activities
Cash Receipts from Sales		50,000
Cash Payments for Expenses		(25,000)
Net Cash Flow from Operating Activities		25,000
Cash Flow from Investing Activities
Purchase of Equipment		(10,000)
Sale of Investments		15,000
Net Cash Flow from Investing Activities		5,000
Cash Flow from Financing Activities
Proceeds from Loan		30,000
Repayment of Loan		(10,000)
Net Cash Flow from Financing Activities		20,000
Net Increase in Cash
Net Cash Flow from Operating Activities		25,000
Net Cash Flow from Investing Activities		5,000
Net Cash Flow from Financing Activities		20,000
Total Net Increase in Cash		50,000

Cash Flow Statement - Lemonade Stand

Particulars		Amount (₹)
Cash Flow from Operating Activities
Cash Receipts from Sales		5,000
Cash Payments for Ingredients		(2,000)
Cash Payments for Supplies (Cups, Napkins)		(500)
Net Cash Flow from Operating Activities		2,500
Cash Flow from Investing Activities
Purchase of a New Lemonade Stand		(1,000)
Net Cash Flow from Investing Activities		(1,000)
Cash Flow from Financing Activities
Loan from Parents		1,500
Net Cash Flow from Financing Activities		1,500
Net Increase in Cash
Net Cash Flow from Operating Activities		2,500
Net Cash Flow from Investing Activities		(1,000)
Net Cash Flow from Financing Activities		1,500
Total Net Increase in Cash		3,000

FAQs on Cost Analysis in Financial Management

Q1: What is cost analysis in financial management?

Cost analysis is the process of evaluating the costs involved in a business decision or operation to understand their impact and make informed decisions.

Q2: What is a cost analysis example?

An example of cost analysis is evaluating the total costs of producing a product, including raw materials, labor, and overhead, to determine if the selling price covers these costs and provides a profit.

Q3: What is the formula for cost analysis?

The basic formula for cost analysis is: $\text{<b><span aria-hidden="true" class="katex-html"><span class="base"><span class="mord text"><span class="mord">Total Cost</span></span><span class="mspace"></span><span class="mrel">=</span><span class="mspace"></span></span><span class="base"><span class="strut"></span><span class="mord text"><span class="mord">Fixed Costs</span></span><span class="mspace"></span><span class="mbin">+</span><span class="mspace"></span></span><span class="base"><span class="strut"></span><span class="mopen">(</span><span class="mord text"><span class="mord">Variable Cost per Unit</span></span><span class="mspace"></span><span class="mbin">×</span><span class="mspace"></span></span><span class="base"><span class="strut"></span><span class="mord text"><span class="mord">Number of Units</span></span><span class="mclose">)</span></span></span></b>}$

Q4: What are the different types of costs in cost analysis?

The different types of costs in cost analysis include:

• Fixed Costs
• Variable Costs
• Direct Costs
• Indirect Costs

Q5: What is the process of cost analysis?

The process of cost analysis involves:

1. Identifying all relevant costs
2. Categorizing costs as fixed or variable
3. Calculating total costs
4. Analyzing the cost data to make informed business decisions

Q6: Is cost statement and cost sheet the same?

No, they are not the same. A cost statement provides a detailed report of the costs associated with producing a product or service, while a cost sheet is a summarized version that typically includes cost-per-unit information.

Q7: How does a cost sheet differ from a cost statement?

A cost sheet summarizes costs on a per-unit basis, often used for internal reporting, while a cost statement provides a detailed breakdown of all costs, used for more comprehensive analysis.