Why is analysing Cash Flow Statements Important?
Created on 13 Sep 2019
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Updated on 28 Jan 2020
Cash flow statement is an important financial statement that analyses and summarises the amount of cash and cash equivalents that enter and leave the company. It measures how effectively a company is utilising its cash balances that is, how well it manages its operating expenses and how well it generates cash to pay its debts.
All the businesses whether it is a Corporate, Joint Hindu Family Business or Limited Liability Partnerships, have to publish their cash flow statements under the Companies Act 2013 with exceptions to one person companies, small companies and dormant companies.
As every company releases its cash flow statement, every investor should go through the details because of the following reasons:
This statement is divided into three activities and parts:
Cash flow from operations: This sections records all the transactions which relates to the regular business operations of the company which may include buying and selling of inventory, payment of salaries to employees, etc.
Cash flow from investing: Under the given section comes all the losses and gains that the company makes from its investments
Cash flow from financing: It is the last section of the CF statement and records the measure the cash between the company and its owners that is, this section records how much dividends are paid out and it also includes the loans received and paid.
Now that we are aware of the cash flow statement and the sections included in it, let us analyse its importance for a company and why you should consider before investing:
Know about Company’s Short Term Plans
Cash flow statement is an important tool which is considered by the management of the company to keep up with the short term plans, meet payment obligations and track the cash inflow and outflow. It assists the management to overview the fund requirements and the amount of liquid assets which are needed to be maintained to payoff and execute the same.
Provides details of where the Money is spent
It gives an insight as to where the money is spent by the organisations which are not available in the profit and loss accounts. Especially the cash flow from the operational activities helps to keep a check on the liquidity position of the company in a short run since it gives details on where the money is spent and coming from.
Creating Excess Cash
The upfront objective of every enterprise is to earn profits and in turn create cash for itself. Analysing the cash flow statement can help the company identify how to make cash through other ways except from that of earning profits. Wherein, a profit and loss account may not be able to clearly indicate and focus on creating cash. This will help you know how much profits are earned by the company.
For Example: if the receivables are managed properly and the money is collected from them faster by managing the inventory efficiently, then excess cash can be created.
Revealing the Cash Planning Results
Referring to the CF statement can help the management realise how well their plans have been executed and its success rate. A relative comparison between the cash budgets and the CF statement can help the company reach onto conclusions and take corrective course of action if required.
These calculations can also assist in setting and a budget for the next term of business cycle. This may also indicate that in situations of extra cash, the company might give out good dividends to its investors.
For Example: The Company expected that the expenditure on the capital asset for the particular month will be $10,000 but the actual was $20,000. So such a variance between expected and actual should be identified by the company and action should be taken accordingly.
Learn about Long Term Plans
It helps executing the long term plans related to the cash. Such kind of long term planning is crucial because the growth of the company is interlinked to it. Therefore, it reveals the changes which are required for a company’s financial positioning and helps the management in prioritizing the important activities of the business.
For Example: Statement of projected cash flow helps the management of the company in identifying the possibility of the long term debt repayment as the same depends on the availability of the cash.
Know the Optimum Level of Cash Balance
It helps in determining the optimum level of Cash Balance which can help the company to ascertain whether the funds of the company are lying idle, or there is a shortage of cash or the funds are in excess. The decisions can be taken accordingly after knowing the actual cash position the management of the company.
For Example: if there is surplus cash lying idle with the company, it can take a decision to invest and you can also take a decision to invest too in the company and vice versa.
Helps in analysing the Working Capital
Working capital is the component of the cash flow from the operations which can influence the cash flow of the companies. Thus the investors should be aware about the working capital movement in the company.
For Example: The Company can reserve its cash by increasing the time for paying the bills, can increase the inflow of the cash by reducing the time for collecting the amount from debtors, and delay in buying inventory for preserving cash etc.
By analysing over these various points the company comes in a position to make necessary changes which will be more beneficial for it and improve the net cash flows and overall financial position and credibility of the company among its stakeholders.
This review and revision of the statement is very important to the investors since it reflects how smoothly is the company able to manage cash and cash equivalents and identify the reasons to not invest in the company.
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