When considering an investment opportunity, some investors believe the organizat

Question

When considering an investment opportunity, some investors believe the organization’s statement of cash flows is the most important factor in evaluating the health of the organization. Others argue that the investors should not use statements of cash flows because they do not show true profitability. For example, depreciation is only considered on the income statement, not on the statement of cash flows. Take a position on whether or not you agree with investor use of statements of cash flows, and provide support for your position.

Explanation / Answer

I agree that Cash Flow Statement is one of the most important factor in evaluating the health of the organization.

In this explanation Cash Flow Statement will be said as CFS

The CFS is part of the financial statements which itself proves how important it is. It tells us how liquid the organization is i.e. will it be able to pay its creditors and other liabilities. It tell how much cash is generated and used in operating, investing and financing activities. It is not considered less critical than Balance Sheet and P & L but it is useful when there is difference between net profits and amount of net cash flow generated by operations. There can be significant difference between the income and CFS for example recording of transaction and actual expenses made or there is revenue recognition but the cash receipts air in future.

The CFS is divided into three parts operating, investing and financing activities.Cash flow from operating activities show how much cash is generated and used in the business. It tells how best the company is producing cash from its business.2) Investing activities shows how much cash is used/generated to purchase/sale long term assets and investments .3) Financing activities includes activities that will change the equity or borrowings of the business.

CFS gives investor a transparent position of the organization which helps them to t.ake a better decision. So investors rely on CFS. Because while making any investment I as an investor will judge a company on its ability to generate cash. Income statement only shows net income as it works on accrual system of accounting but in actual the cash can be less or more . So if the company actually generated sufficient cash i.e. the cash rich companies are less risky and better to invest.

So, it is an important factor in evaluating the health of the organization.

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