From Ask the Expert! What is cash flow and why so we prepare that statement?
by Manoj Gor
Please guide me why do we prepare Indirect method cash flow and what type of business picture is shown in this format, and why do we use particular head in this format like, interest income/expense/ dividend/ Investment
i need complete understanding for cash flow
The reason we prepare a Statement of Cashflows is because your Income Statement only gives you part of the picture. It gives you sales less expenses equals profit.
But some things you use cash for do not affect profit - for example principal portions of loan payments, owner withdrawals or contributions, cash from loan proceeds, pay down on accounts payable...these things use your cash or contribute to your cash, but do not affect either income (sales) or expenses.
So to get a true picture of how much cash your company has used or added to your cash balance for a period of time, you need to prepare a Statement of Cashflows.
The format that is used was developed long ago, and separates out your operations, investing activities, and financing activities. This helps you understand which of these activities is contributing to or using the most of your cash.
Hope that helps!