Cash Flow analysis
Clearly, income statements and statements of financial position are the most common financial documents available to the public. But managers who make financial decisions may find themselves at something of a loss if they only have these two documents (reports on past performance) on which to base their decisions for today and into the future.
Financial managers and investors, however, are far more interested in actual cash flows than they are in somewhat artificial, back-ward looking accounting profit listed on income statements. This is very important distinction between the accounting and finance point of view. Finance professionals know that the firm need cash, not accounting profit, to pay the firm’s obligation as they come due, to fund firm’s operation and growth, and to compensate the firm’s ultimate owners (its shareholders). Thus, the statement of cash flows is a financial statement that shows the firm’s cash flows over a given period of time. This statement reports the amount of cash that the firm generated and distributed during a particular time period. The bottom line on the statement of cash flows 9the difference between cash resources and uses) equals the change in cash on the firm’s statement of financial position from the previous year’s cash account balance. That is, the statement of cash flows reconciles income statement items and noncash statement of financial position items to show changes in the cash and marketable securities account on the statement of financial position over the particular analysis period.
Usefulness of the statement of cash flows
“Happiness is a positive cash flow” is certainly true. Although net income provides a long-term measure of a company’s success or failure, cash is its lifeblood. Without cash, a company will not survive. For small and newly developing companies, cash flow is the single most important element for survival. Even medium and large companies must control cash flow.
The statement of cash flow required by PAS 7 provides information about cash inflows and outflows during an accounting period as well as the net change in cash from the operating, investing and financing activities in a manner that reconciles the beginning and ending cash balances.
The statement of cash flow is a valuable analytical tool for managers as well as investors and creditors because it answers questions that cannot be answered by the income statement and balance sheet. Some such vital questions are:
1. Is the company generating sufficient positive cash flows from its ongoing operations to remain variable?
2. Will the company be able to meet its financial obligations to creditors?
3. What expansion activities took place and how were those financed?
4. Will the company be able to pay to its customary dividend?
5. Why did cash decrease even though a net income was reported?
6. To what extent will the company have to borrow money in order to make needed investments?
7. What happened to proceeds received from the issuance of capital stock?
One should recognize that companies can fail even though they report net income. The difference between net income and net cash provided by operating activities can be substantial.
Analysts increasingly use cash-flow-based measures of income, such as cash flow provided by operations instead of or in addition to net income. The reason for the change is that they question he accrual-based net income numbers.
In addition, the statement of cash flows provide means of measuring a business firm’s
A. Financial liquidity – This refers to the “measures of cash” of assets and liabilities.
Current cash debt ratio:
Net cash provided by Operating Activities
Current Cash Average Current Liabilities
Debt Coverage Ratio
The higher the current cash debt coverage ratio, the less likely a company will have liquidity problems. For example, a ratio...
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