Many sophisticated investors and analysts consider the Statement of Cash Flows t

Question

Many sophisticated investors and analysts consider the Statement of Cash Flows to be the most informative of the basic financial statements, particularly relative to the Company’s ability to generate cash to reinvest in the business.

Briefly explain the information about the company that an investor [or potential investor] would be able to determine from an analysis of the company’s reported Statement of Cash Flows that would not be as easily determinable from the Income Statement or Balance sheet.

Include in your response an explanation of why you would you find this information relevant to your investment decision.

Explanation / Answer

A cash flow represents a true picture of cash inflow and cash outflow during a period of time. While Income statement provides information on the performance of a firm through earnings figures, earnings does not represent cash and it is cash that a business requires to run the operations as well as pay its creditors to sustain and grow. The analysis of cash flow statement will help the company gauge the amount of cash sourced and used by the business during its course of operations. The cash flow statement can be represented in both direct and indirect way with respect to cash flow from operations. The entire cash flow in a business can be represented by taking three main perspectives

a) Operations

The cash generated as used in operating cycle of a business will be represented here. Operating cycle is defined as the cash to cash cycle. The business uses cash for working capital expenses like buying inventory some of which in credit ,the operating expenses for converting the raw material to finished goods will have to be borne in cash while the finished goods are not entirely realized in cash as some of it still will be as receivables for providing credit terms to the customer. Thus a firm has to manage this entire cycle as it has to generate enough cash to maintain this cycle. A firm may report sales figures for a month while the cash could be zero as the entire sales could be sold on credit terms. Thus keeping an eye on the operating cash flows is important as an investor as it is these cash flows that are used for investments as well as repayment of finance.

Investment Cash flows

Cash flow from investment activities are those cash flows arising out of sale of assets or cash outflows due to new investments etc. These are related to long term planning. If a company consumes large amount of cash for investments one could gauge that the firm is reinvesting for future growth which could provide value to investors. If cash flow from operations is insufficient to meet the operating expenses then financing cash flows are used.

Financing Activities

Cash flows from financing represent cash flows to and from external financiers like banks, bondholders, equity shareholders. The cash flow from financing is important indicator of how much leverage is a company using and what the ideal capital structure needs to be for the company to provide value to shareholders.

Related Questions

Navigate

• Browse (All)
• Browse M
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.