STATEMENT OF CHANGES IN FINANCIAL POSITION (SCFP): CASH BASIS Homework Help

STATEMENT OF CHANGES IN FINANCIAL POSITION (SCFP): CASH BASIS

The statement of change in financial position based on working capital is of immense use in long-range financial planning. The long-term financing and investment activities are specifically portrayed. The net working capital requirements (in one lump sum amount) are shown as a residual figure. However, the working capital concept may conceal or exclude too much. It treats increases in inventories and accounts receivable as equivalent to increase in cash. Likewise, an increase in accounts payable and accrued expenses are treated as equivalent to an increase in bank overdraft. This is not a correct treatment. In fact, accrued expenses like wages and salaries may become payable in the next 10 days or so; sundry creditors bills may fall due for payment during the next one month, whereas bank overdraft may be for a longer period of say three months or even more. Similarly, inventories and accounts receivable undergo a transformation before they become money assets (cash).

It is possible that there is sufficient net working capital as revealed by the statement of changes in financial position and yet the firm may be unable to meet its current liabilities as and when they due. It may be due to a sizable piling up of inventories and an increase in debtors caused by a slow-down in collections. The firm's failure to meet its short-term commitments, in spite of its sound long-range financial position and adequate profitability, may plunge it into technical insolvency. Therefore, in making plans for the more immediate future (short-range financial planning), the management is vitally concerned with a statement of cash flows which provides more detailed information. Such a statement is useful for the management to assess its ability to meet obligations to trade creditors, to pay hank loans, to pat interest to debenture holders and dividends to its shareholders.

Furthermore, the projected cash flow statements prepared month-wise or so'(which are constructed like the funds statement) can be useful in presenting information of excess cash in some months and shortage of cash in others. By making available such information in advance, the statement of cash flows enables the management to revise its plans. In the months when cash receipts arc expected to be greater than cash payments, bank overdraft can be repaid, short-term government securities can be purchased, cash discount can be availed of and so on. Likewise, in the months when cash payments are expected to exceed receipts, the firm would be required to arrange for hank overdraft or sell its marketable securities.

In essence, cash flow statements are statements of changes in financial position prepared on the basis of funds defined as cash or cash-equivalents. In short, cash flow statements summarize sources of cash inflows and uses of cash outflows of the rum during a' particular period of time.

Posted by: andy

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