Test: Cash Flow Statements - UGC NET MCQ

One of the main objectives of a cash flow statement is to facilitate short-term financial planning. This statement helps organizations manage their cash effectively in the short term by providing insights into the inflows and outflows of cash. By analyzing the cash flow statement, businesses can anticipate cash needs, manage liquidity, and ensure smooth operations. It is a crucial tool for ensuring that a company has enough cash to meet its short-term obligations and take advantage of opportunities as they arise.

Key Points
Discounting:

• The process of converting cash flow into present equitable is called Discounted Cash Flow (DCF) analysis.
• The goal of DCF analysis is to estimate the value of an investment, business, or asset based on its expected future cash flows, discounted to its present value using a discount rate that reflects the risk associated with the investment.
• In other words, DCF analysis involves estimating the future cash flows that an investment is expected to generate, determining the appropriate discount rate to reflect the risk of those cash flows, and then calculating the present value of those cash flows by discounting them back to their present value.
• The resulting present value is then used to determine whether the investment is worth undertaking or not, based on the investor's required rate of return.

Key Points

Cash Flow Statement:

• An organization's inflows and outflows of cash and cash equivalents over a given time period are shown in a statement called a "cash flow statement."
• There are three sections in a cash flow statement: operating activities, investments, and financial activities.
• The cash flow activities known as "operating activities" are those that either produce income or keep track of the money spent on creating a good or service.
• The gains and losses resulting from investments in assets like property, plant, or equipment (PPE) are listed in the second section of the cash flow statement, which reflects the overall change in a company's cash position.
• The cash flow between the business and its owners, creditors, and other parties is tracked in the third section of the cash flow statement known as Financing Activities.

Fund Flow Statement:

• A fund flow statement compares the two balance sheets by examining the funding sources (debt and equity capital), the funding used (assets), and the reasons behind any discrepancies.
• It makes it easier for the business to track where its finances have been spent and where they have come from (long-term funds raised by issues of shares, debentures, and sales of non-current assets).

Important Points

Funds and cash flow statements are crucial management tools that provide the company with information about:

• These statements explain the causes of changes in the operating, investing, and financing activities of the organization along with the changes in the assets and liabilities between two different points of time. Such changes also have implications for the liquidity position of the company.
• It's a realistic dividend policy, as sometimes a firm has sufficient profit available for distribution as a dividend. These statements act as a guide for the future for the management.
• It helps in planning the repayment of loans, the replacement of fixed assets and other capital expenditure decisions.
• Since an organization gets to know the position of cash and the changes in its working capital, these help them with external financing as various stakeholders are interested in the investment avenues of the organization.

Thus, the correct solutions are A, B, C and D

Key Points 

The correct answer is:

a. Share issued for cash.
b. Dividend distributed to shareholders.
d. Redemption of debentures.

Financing activities are those activities that involve raising capital or repaying capital to the providers of finance. They typically involve transactions related to equity and debt financing. Let's analyze each option:

a. Share issued for cash: This transaction represents the issuance of shares in exchange for cash. It is a financing activity because it involves raising capital from shareholders.

b. Dividend distributed to shareholders: This transaction represents the distribution of profits to shareholders in the form of dividends. While it does not directly involve raising or repaying capital, it is considered a financing activity as it relates to the return of funds to the providers of finance.

c. Sale of machinery: This transaction represents the sale of an asset, which is not directly related to financing activities. It falls under the category of investing activities as it involves the sale of a long-term asset.

d. Redemption of debentures: This transaction represents the repayment of debentures, which are long-term debt instruments. It is a financing activity as it involves the repayment of borrowed capital.

e. Provision for depreciation: This transaction does not directly relate to financing activities. It falls under the category of operating activities as it represents the recognition of an expense associated with the wear and tear of assets over time.

In summary, options a, b, and d are related to financing activities, while options c and e are not.

A cash flow statement primarily displays the cash inflows and outflows of a business during specific time periods. It helps in understanding how cash moves in and out of a company over a given period, aiding stakeholders in assessing the liquidity and financial health of the business.

As outlined in the Cash Flow Statement chapter, cash comprises physical currency and bank balances, while cash equivalents are highly liquid assets that can be quickly converted into known cash amounts with minimal risk of value fluctuation. This distinction is crucial for understanding the different forms of liquidity within a business's financial operations.

• Assertion: The assertion is true. Cash flow from financing activities indeed reflects changes in the owner's capital and borrowings.
• Reason: The reason is false. Financing operations are not primarily related to investments in fixed assets.
• Explanation: While the assertion is correct, the reason provided does not correctly explain the assertion. Financing activities encompass a broader scope beyond just investments in fixed assets.

Key Points

•  Cash flow statement: An organization's cash flow can be monitored by using a cash flow statement, which is a crucial tool for managing finances.
• The cash flow statement allows to maintain the tracking of incoming (inflow) and outgoing (outflow) cash by displaying the source of that money.
• Cash flow statement helps in maintaining optimum cash balance in the organization.
• There are three types of activities involve in cash flow statement, namely:
  • Operating Activities
  • Investment Activities
  • Financing Activities

Important Points

• Operating Activities: The cash flow activities known as "operating activities" are those that either generate cash or keep track of the funds used to produce a good or service.
  • It includes tax payment, advertisement expense, inventory transactions, wages etc.
• Investment Activities: The gains and losses from investments in assets like property, plant or equipment (Purchase of furniture, building etc.) are recorded in this section of the cash flow statement, that shows the overall shift in a company's cash position.
• Financing Activities: The cash flow between the business and its shareholders and creditors appears in this area of the cash flow statement.
  • It includes transactions like equity, debt, dividend etc.
• So, Cash Flow Analysis is an important financial tool for the management. Its main advantages are:
  • It ​ helps in cash management
  • It helps in internal financial management
  • It discloses the movements of cash
  • It helps in Capital budgeting decisions​

​Hence, the correct answer is (a), (c) and (d) only

In a business, cash flows refer to the movement in and out of cash and cash equivalents. This includes cash receipts from sales, investments, or financing activities, as well as cash payments for expenses, investments, or debt. Understanding cash flows is crucial for assessing a company's financial health and its ability to generate cash for operations and growth.

Assertion: The assertion is true. Cash flow from operating activities indeed encompasses a company's key revenue-generating activities.

Reason: The reason is false. Cash flow from investing activities primarily deals with the purchase and sale of long-term assets and investments, not operating revenues.

Explanation: While the assertion holds, the reason does not correctly explain the assertion, as cash flow from investing activities focuses on asset transactions rather than revenue generation.