Cash, Cash Equivalents and Cash flows

Cash flow statement is a statement that measures the inflows and outflows of cash and it summarizes the amount of cash and cash equivalents entering and leaving a company from various activities of an enterprise during a particular period of time.

‘Cash’ means the cash which is available in hand and any demand deposits with the banks, whereas,

‘Cash equivalents’ are highly liquid short term investments, they have high credit quality and can be easily converted into known amounts of cash. Due to this, they are not prone to any risk of change in value.

Having cash and cash equivalents speaks a lot about the company’s health, as it shows the firm’s ability to pay its short term debt.




Investments in liquid securities such as stocks, bonds and derivatives are not included in cash and cash equivalents. Only when an investment has a short maturity of three months or less from the date of its acquisition, then it qualifies as cash equivalents. Therefore, investments in shares are excluded from cash equivalents unless they are in substantial cash equivalents.

Examples of cash equivalents are: money market funds, short term government bonds, treasury bills etc.

Cash flows :

Cash flow is the increase or decrease or the upward or downward movement of the cash of the business. It can simply be defined as the movement of cash to undertake transactions involving some non-cash items.

Cash inflow is the receipt of cash from a non-cash item, whereas, cash outflow is the cash payment of such items. Eg. purchase of building by paying cash leads to outflow of cash and any inflow through sale of such building is termed as cash inflow.

Cash flow gives an idea of the amount of cash coming into the business, from where and the amount flowing out, it can either be positive or negative and is used to analyze the liquidity position of the company.

Classification of activities for preparing the cash flow statement :

Various activities of an enterprise result in cash flows (inflows or receipts and outflows or payments) which are present in a cash flow statement.




The three categories of cash flows are; ‘Operating activities’, ‘Investing activities’, ‘Financing activities’.

Operating activities include cash activities related to conduct of ordinary business.

Investing activities include cash activities related to investment in non-current assets like machines, buildings etc.

Financing activities include cash activities related to non-current liabilities and owner’s equity (capital).

Thus, cash flows generated or used are bifurcated into these three types of activities separately. This enables the various users/ stakeholders to determine the capability and efficiency of these activities on the overall financial position of the company.

Thus, cash and cash equivalents, cash flows and classification of activities for preparing the cash flow statement are the prerequisites for preparing a cash flow statement.

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