Power of Cash Flows
The Power of Cash Flow Ratios
EXECUTIVE SUMMARY
CASH FLOW RATIOS ARE MORE RELIABLE indicators of liquidity than balance sheet or income statement ratios such as the quick ratio or the current ratio. LENDERS, RATING AGENCIES AND WALL STREET analysts have long used cash flow ratios to evaluate risk, but auditors have been slow to use them. SOME CASH FLOW RATIOS COMPARE THE RESOURCES A company can muster with its short-term commitments. OTHER CASH FLOW RATIOS MEASURE A COMPANYS ability to meet ongoing financial and operational commitments. THERE IS NO CONSENSUS ON THE DEFINITION OF NET free cash flow, although the authors suggest taking off-balance-sheet financing into account. AUDITORS CAN USE THE INSIGHTS uncovered by cash flow ratios to spotlight potential problem areas, thus helping them plan their audits more effectively.
JOHN R. MILLS, CPA, PhD, is a professor in the Department of Accounting and CIS at the University of Nevada, Reno. His e-mail address is www.mills@scs.unr.edu1. Mills experience includes auditing and consulting in the gaming industry.
JEANNE H. YAMAMURA, CPA, PhD, is an assistant professor in the accounting and CIS department at the university 's Reno campus. Her e-mail address is www.yamamura@unr.edu2. Yamamura worked as an auditor overseas, including a stint in Papua, New Guinea.
To fully understand a company 's viability as an ongoing concern, an auditor would do well to calculate a few simple ratios from data on the clients cash flow statement (the statement of sources and uses of cash). Without that data, he or she could end up in the worst possible position for an auditor—having given a clean opinion on a client 's financials just before it goes belly up.
When it comes to liquidity analysis, cash flow information is more reliable than balance sheet or income statement information. Balance sheet data are static—measuring a single point in time—while the income statement contains many arbitrary
EXECUTIVE SUMMARY
CASH FLOW RATIOS ARE MORE RELIABLE indicators of liquidity than balance sheet or income statement ratios such as the quick ratio or the current ratio. LENDERS, RATING AGENCIES AND WALL STREET analysts have long used cash flow ratios to evaluate risk, but auditors have been slow to use them. SOME CASH FLOW RATIOS COMPARE THE RESOURCES A company can muster with its short-term commitments. OTHER CASH FLOW RATIOS MEASURE A COMPANYS ability to meet ongoing financial and operational commitments. THERE IS NO CONSENSUS ON THE DEFINITION OF NET free cash flow, although the authors suggest taking off-balance-sheet financing into account. AUDITORS CAN USE THE INSIGHTS uncovered by cash flow ratios to spotlight potential problem areas, thus helping them plan their audits more effectively.
JOHN R. MILLS, CPA, PhD, is a professor in the Department of Accounting and CIS at the University of Nevada, Reno. His e-mail address is www.mills@scs.unr.edu1. Mills experience includes auditing and consulting in the gaming industry.
JEANNE H. YAMAMURA, CPA, PhD, is an assistant professor in the accounting and CIS department at the university 's Reno campus. Her e-mail address is www.yamamura@unr.edu2. Yamamura worked as an auditor overseas, including a stint in Papua, New Guinea.
To fully understand a company 's viability as an ongoing concern, an auditor would do well to calculate a few simple ratios from data on the clients cash flow statement (the statement of sources and uses of cash). Without that data, he or she could end up in the worst possible position for an auditor—having given a clean opinion on a client 's financials just before it goes belly up.
When it comes to liquidity analysis, cash flow information is more reliable than balance sheet or income statement information. Balance sheet data are static—measuring a single point in time—while the income statement contains many arbitrary
References: ^www.mills@scs.unr.edu (www.readability.com) ^www.yamamura@unr.edu (www.readability.com) ^Exhibit 1 (www.journalofaccountancy.com) ^exhibit 2 (www.journalofaccountancy.com) ^case study (www.journalofaccountancy.com)