Question

A household functions like a small business. In both the household and business settings, the importance of stable cash flow cannot be emphasized enough. Households and businesses must maintain good cash flow to meet their continued obligations should something happen or if there is an economic downturn. Planning for both short- and long-term cash needs is important to both the household entity and the business entity 1. Identify the three categories that appear on a Statement of Cash Flows and give two examples of items that are shown under each particular category. (9 points) 2. Of the four primary financial statements used in accounting, managers often indicate that the Statement of Cash Flows is the most beneficial statement, in their opinion. Why do you suppose they believe this particular statement to be so important? (5 points) 3. In your opinion, what are three factors that should determine how much money should be set aside in an emergency fund" for both a household and a business? (6 points)

Answer 1

1.The three categories that appear on Statement of Cash Flows along with the examples are as follows:

Operating activities:

Operating activities include the production, sales and delivery of the company's product as well as collecting payment from its customers, purchasing raw materials, building inventory, advertising etc

• Payments to suppliers for goods and services
• Interest received on loans

Financing activities:

Financing activities include the inflow of cash from investors such as banks and shareholders, as well as the outflow of cash to shareholders as dividends as the company generates income

• Payments of dividends
• Payments for buy-back of company shares

Investing activities:

• Purchase or Sale of an asset
• Investment for acquisition of a company

2. The cash flow statement is important because -

• A cash flow report determines whether a business has enough cash to pay its expenses, to pay bank loans, to pay taxes and to purchase new assets.
• Having cash is a key requirement for a business to stay solvent. When a business has no longer enough cash to pay its dues, it is often declared bankrupt.
• Large companies will often have a significant amount of non-cash transactions, sometimes even billions in revenue account that is simply owed to them but hasn’t been received in cash yet. In these situations, a profit and loss statement is not always sufficient, and a cash flow report is valuable to many users, such as banks and shareholders.
• Cash position of the company can not only help the company or the financial analyst to plan for the short term or long term but also in analyzing the optimum level of cash and working capital needed in the company.
• Cash flow statement helps companies in analyzing the extent to which the cash planning of the company became successful as the actual results can be compared with the projected statement of Cash Flow Statement or the Cash budget.

3.The three factors that should determine funds to be kept aside aside in emergency fund are:

• Estimate of basic expenses to be incurred on daily and monthly basis.
• Estimate of time period for which an emergency will last , say one month or 3 months.
• Estimate of passive income , if any generated by household or business which can be utilised during the period of emergency.