The Importance of the Statement of Cash Flow
For years, the importance of cash flows has been drilled into the heads of college students while learning the methodology of accounting. Despite many name changes over time, the cash flow statement is said to be the most important of the three financial statements. One may ask themselves, why is the cash flow statement so important? The answer is to always follow the cash. Following the cash will uncover minute details one may never discover while looking at other financial statements, and truly shows the firm's current financial health specific to a certain time period. Once called the statement of change in working capital, the cash flow statement has significant value to business owners, as well as investors.
A statement of cash flow is a financial report that goes into detail about the origins of a firm's cash, and also includes how that cash was spent over a specific period of time. An important factor of this financial statement is that it does not include non-cash items. Such as depreciation. When non-cash items are excluded, the statement becomes a useful tool for the firm to determine the sustainability of the firm, including their ability to pay their debts.
The income statement and the cash flow statement are similar in a way that both statements record a firm's performance over a specific time period. The difference lies within the inclusion of non-cash items. The income statement includes the non-cash items, whereas mentioned before, the statement of cash flow excludes the non-cash items. The cash flow statement reveals exactly how much money was generated by the firm, as well as the performance of how cash inflows and outflows were managed. It is possible for a firm to look both profitable on the balance sheet as well as the income statement, however the statement of cash flow will provide clarity as to where the cash inflows are actually incurred. If there is a drop in cash on hand, the firm threatens their ability to pay back lenders. This puts the firm in a riskier position of financial health when compared to a firm with a lower net income, but a stronger level of cash flow.
There are three parts to the cash flow statement: cash from operations, cash from financing, and cash from investing; all of which all boils down to a firm's net increase or decrease in cash for the specific time period. The operating section includes cash generated from daily business activities. The investment section is comprised of cash used for the investment of assets, as well as the proceeds from the sale of other businesses, equipment, or other long-term assets. Cash from financing contains cash paid, or received, from the issuing and borrowing of funds. Dividends paid are also included in the financing section of the cash flow statement. When all is said and done, the equating number is the firm's increase or decrease in cash from the previous period. Brackets will surround this number if negative. From the point of view of the firm, it can use the cash flow statement to evaluate it's financial performance and financial health, in both short-term and long-term, as well as look for ways to become more efficient in cash management.
Investors also find cash flow statements very useful when analyzing a firm in terms of whether or not the firm is profitable and in good financial health. This statement also helps point out any fraudulent activity, if any, that has been performed by the firm. As mentioned before, the cash flow statement is stripped of non-cash items. This helps the investors gain a clearer picture of how much the firm is actually profiting, or losing, once all the accounting conventions are taken out of the income statement. The number they looked for is generally referred to as "EBIT" or "EBITDA." EBITDA simply stands for "earnings before income tax, depreciation, and amortization." Once the non-cash items are removed from the equation, investors can now make a more educated investment by looking at actual cash flows, and profitability of the firm. Investors cannot make an educated investment based solely on net-income found on the income statement due to the simple fact that the bottom line number does not always tell the whole story. The real story lies within the cash flow statement. When in doubt, follow the cash; the cash does not lie.
Cash is to a business as oxygen is to fire. Without oxygen there is no fire, and without cash there is no business. The statement of cash flow has proven itself useful for business owners, investors, as well as lenders to track the performance of how good a firm is at meeting their short-term obligations and planning for future long-term growth. Proper cash management is a vital task for a firm in order to increase shareholder wealth and the profitability of a firm. This is why the statement of cash flow is crucial to a firm's sustainability.
A statement of cash flow is a financial report that goes into detail about the origins of a firm's cash, and also includes how that cash was spent over a specific period of time. An important factor of this financial statement is that it does not include non-cash items. Such as depreciation. When non-cash items are excluded, the statement becomes a useful tool for the firm to determine the sustainability of the firm, including their ability to pay their debts.
The income statement and the cash flow statement are similar in a way that both statements record a firm's performance over a specific time period. The difference lies within the inclusion of non-cash items. The income statement includes the non-cash items, whereas mentioned before, the statement of cash flow excludes the non-cash items. The cash flow statement reveals exactly how much money was generated by the firm, as well as the performance of how cash inflows and outflows were managed. It is possible for a firm to look both profitable on the balance sheet as well as the income statement, however the statement of cash flow will provide clarity as to where the cash inflows are actually incurred. If there is a drop in cash on hand, the firm threatens their ability to pay back lenders. This puts the firm in a riskier position of financial health when compared to a firm with a lower net income, but a stronger level of cash flow.
There are three parts to the cash flow statement: cash from operations, cash from financing, and cash from investing; all of which all boils down to a firm's net increase or decrease in cash for the specific time period. The operating section includes cash generated from daily business activities. The investment section is comprised of cash used for the investment of assets, as well as the proceeds from the sale of other businesses, equipment, or other long-term assets. Cash from financing contains cash paid, or received, from the issuing and borrowing of funds. Dividends paid are also included in the financing section of the cash flow statement. When all is said and done, the equating number is the firm's increase or decrease in cash from the previous period. Brackets will surround this number if negative. From the point of view of the firm, it can use the cash flow statement to evaluate it's financial performance and financial health, in both short-term and long-term, as well as look for ways to become more efficient in cash management.
Investors also find cash flow statements very useful when analyzing a firm in terms of whether or not the firm is profitable and in good financial health. This statement also helps point out any fraudulent activity, if any, that has been performed by the firm. As mentioned before, the cash flow statement is stripped of non-cash items. This helps the investors gain a clearer picture of how much the firm is actually profiting, or losing, once all the accounting conventions are taken out of the income statement. The number they looked for is generally referred to as "EBIT" or "EBITDA." EBITDA simply stands for "earnings before income tax, depreciation, and amortization." Once the non-cash items are removed from the equation, investors can now make a more educated investment by looking at actual cash flows, and profitability of the firm. Investors cannot make an educated investment based solely on net-income found on the income statement due to the simple fact that the bottom line number does not always tell the whole story. The real story lies within the cash flow statement. When in doubt, follow the cash; the cash does not lie.
Cash is to a business as oxygen is to fire. Without oxygen there is no fire, and without cash there is no business. The statement of cash flow has proven itself useful for business owners, investors, as well as lenders to track the performance of how good a firm is at meeting their short-term obligations and planning for future long-term growth. Proper cash management is a vital task for a firm in order to increase shareholder wealth and the profitability of a firm. This is why the statement of cash flow is crucial to a firm's sustainability.