Text III. Statement of Cash flows, cash budget and trial balance
The Statement of cash flows measures the liquidity and the flow of cash of a business. Specifically, it is the activity of the cash account of a business. Sales are recorded as cash inflows through point of sale (POS) systems and expenses are recorded as cash outflows through accounts payable or electronic transfers. It is important for a manager to know how much cash is available in the company’s cash account to pay expenses and to plan for future operating obligations. If a business does not have sufficient cash in its cash bank account, it will not be able to pay expenses. It is an important responsibility of any manager to understand the business’s working capital accounts and to be able to use them efficiently. The increases and decreases in account balances of balance sheet accounts also affect cash flow. Referred to as the source and use of funds statement, this report describes how cash flows in and out of the different accounts in the Balance sheet. This also reflects the cash strength or liquidity of a business. Liquidity is the ability of a business to pay its short-term obligations and the amount it has in current assets, specifically cash and cash equivalents. It is important for every manager to understand that a business can be profitable from month to month and still go out of business.
If managers simply do not have enough money in their cash account to pay expenses; therefore, they go out of business even though they show profits on their P&L Statement and have a fairly good balance sheet. If you cannot pay your expenses, you cannot stay in business. Therefore, understanding the basics of managing cash flow is critical to the success of both managers and a business.
Key characteristics of the statement of cash flows
Key characteristics of the Statement of cash flows are as follows:
1. It involves the cash account of the Balance sheet.
2. It has beginning and ending balances.
3. It shows how money is used in the daily operations of the business.
4. It measures liquidity.
5. It is a fundamental component of working capital.
6. It reflects the increases and decreases in Balance sheet accounts.
The purpose of a statement of cash flows is to provide information about the cash receipts and cash payments of the entity, and how they relate to the entity's operating, investing, and financing activities. Readers of financial statements use this information to assess the solvency of a business and to evaluate its ability to generate positive cash flows in future periods, pay dividends, and finance growth.
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These cash flows are computed by converting the income statement amounts for revenue, cost of goods sold, and expenses from the accrual basis to the cash basis. This is done by adjusting the income statement amounts for changes occurring over the period in related balance sheet accounts.
Cash budget
Most businesses do not have equal inflows and outflows of cash. In the Hospitality industry it is not unusual to have peak seasons with high occupancy when hotels charge the highest rates and off-seasons with low occupancy and the lowest rates. During the peak periods hotels have great inflow of cash and they need to meet current financial obligations.
If a business is to be prepared to deal successfully with such dramatic changes in the inflows and outflows of cash, it is obvious that planning must take place. For this purpose cash budget is prepared. It is a financial statement which predicts the sources and uses of funds for the period covered. Cash budgets are normally prepared for one year in advance.
Trial balance
The trial balance can be prepared at any time, but is most often prepared at the end of the period. It is prepared after all of the day-to-day journal entries have been recorded, and all of these entries have been posted to the general ledger. For the trial balance, all of the balances from all T-accounts are taken and summarized.
Vocabulary test_______________________________________________________
1. Main accounting documents reveal how a company … money.
a) retains b) remains c) reflects d) responds
2. All … were recorded to the general ledger.
A) exits B) entrances C) entriesD) enterprises
3. The accountant calculated … ratios and commented on the financial position of the company.
A) valuable B) appropriateC) valid D)appreciative
4. Gross profit is a … obtained on P&L when the cost of goods is deducted from revenue.
A) mark B) markup C) feature D) figure
5. … suppliers tend to demand quick payments, customers usually insist on extended credit.
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A) during B) whileC) till D) beyond
6. Any … amount of money is considered to be a profit.
A) solitary B) remaining C) refraining D) retired
7. Internal auditors are looking for … from standard operating procedures.
A) variations B) options C) deviationsD) devastation
8. In a journal accountants record business transactions as they occur … to posting the information.
A) predominantly B) preceding C) prior D) precisely
9. Overheads are the costs … in running a business that are not directly attributable to a product or service.
A) inserted B) insulted C) introduced D) incurred
10. The company’s directors are … to the company’s shareholders.
A) accountable B) answerable C) reporting D) fiscal
Multiple Choice Questions______________________________________________
1. Another term for a positive financial return or net income is:
a. revenue
b. profit
c. credit
d. margin
2. Depreciation is:
a. the amount of money spent
b. the fixed asset
c. the part of the cost of the asset consumed during its period of use
d. the amount of money spent to pay debts
3.The physical examination of financial records to determine accuracy is called:
a. inventory
b. inspection
c. auditing
d. investigation
4. The financial statement which shows cash activity (receipts ) during the accounting period is called a(n):
a. bank statement
b. statement of cash flows
c. income statement
d. bank reconciliation
5. Which of the following is a record of all the account balances at the year end, and is used to prepare the final accounts?
a. a trial balance
b. a statement of financial position
c a statement of cash flows
d an income statement
6. The balance sheet item that represents the resources invested by the owner is:
a. accounts receivable
b. cash
c. note payable
d. owner’s equity
7. Suppliers and creditors of a firm are interested in:
a. profitability position
b. liquidity position
c. market share position
d. debt position
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8. A firm’s liquidity shows:
a. its profit level
b. the amount of sales it makes
c. how much VAT it pays
d. its ability to pay debts
Defining the terms_____________________________________________________
| 1. balance sheet | a) the movement of cash into and out of a business |
| 2. liquidity | b) a piece of paper that lists financial details |
| 3. cash flow | c)a document describing the financial position of a company at a particular point in time |
| 4.balance | d) a book in which business items are recorded |
| 5. depreciation | e) regular costs that are involved in operating a business |
| 6. statement | f) the amount of money in a bank account |
| 7. ledger | g) the ease with which an asset can be sold |
| 8. overheads | h) the process of losing value |
Writing______________________________________________________________
1. Is the process of analyzing the company’s financial statements essential for the profitability of business? To what extent? And why must all statements be checked by auditors?
2. Explain why truthful information is vital for all financial players and how lack of information can affect distress of investors and solvency of the company.
3. Why do many people consider that accountancy is a great career choice? Identify their reasons.
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