Usefulness of Cash Flow Statement
The purpose of cash flow statement is to provide information about the cash flows associated with the periods of operations and also about the entity’s investing and financing activities during the period. This information is important to shareholders, part of whose investment return (dividends) is dependent on cash flows and to lenders, whose interest payment and principal repayment require the use of cash. The welfare of other constituents of a company including its employees, its suppliers, and the local bodies that may levy taxes on it, depends to varying degrees on the company’s activity to generate adequate cash flows to fulfil its financial obligations. The usefulness of cash flow statement can be summarised as follows:
- Predict future cash flows: The cash flow statement makes it possible to predict the amounts, timing and uncertainty of future cash flows on the basis of what has happened in the past. This approach is better than accrual basis data presented by Statement of Profit & Loss and the balance sheet.
- Determine the ability to pay dividends and other commitments: A cash flow statement indicates the sources and uses of cash under suitable headings such as operating, investing and financing activities. Shareholders are interested in receiving dividends on their investments in the shares. Creditors want to receive their interest and principal amount on time. The statement of cash flows helps investors and creditors to predict whether the business can make these payments.
- Show the relationship of net income to changes in the business cash: Usually cash and net income move together. High levels of income tend to lead to increase in cash and vice-versa. However, a company’s cash balance can decrease when its net income is high, and cash can increase when income is low. The users want to know the difference between the net profit and net cash provided by operations. The net profit shows the progress of the business during the year while cash flow relates more to the liquidity of the business. The users can assess the reliability of net profit with the help of cash flow statement.
- Efficiency in cash management: Cash flow analysis helps in evaluating financial policies and cash position. It facilitates the management to plan and co-ordinate the financial operations properly. The management can estimate how much funds are needed, from which source they will be derived, how much can be generated internally and how much should be arranged from outside.
- Discloses the movement of cash: A comparison of cash flow statement for the previous year with the budget for that year would indicate to what extent the resources of the enterprise were raised and applied. A comparison of the original forecast with actual result may highlight trend of movement that might otherwise remain undetected.
- Discloses success or failure of cash planning: A success or failure of cash planning can be known by comparing the projected cash flow statement with the actual cash flow statement and necessary remedial measures can be taken. Moreover it provides a better measure for inter-period and inter-firm comparison.
- Evaluate management decisions: The statement of cash flows reports the companies’ investing and financing activities and thus gives the investors and creditors about cash flow information for evaluating managers’ decisions.