Purpose and importance of cash flow statements in assessing financial strength

Cashflows

The cash flow statement is a critical tool for financial planners and analysts interested in assessing the health and wellness of a company from a financial and operational perspective. The statement of cash flows provides information about the cash payments received by a company during a defined period; the amount that should be received from cash receipts is also reported (Kieso, Weygandt, & Warfield, 2007). This is critical information a company needs to determine how well their products and services are doing. The cash flow information assesses whether products and services are bringing in revenues for the company. Cash flow does not includes revenues coming in as interest or credit however, for the month the receipt is issued say for the charge incurred, or when the loan is given. There is a system of checks and balances. The system in place is highly organized to capture a big picture sense of how well a company is doing. Cash flows generally reflect an upward trend in cash flows, provided a company does well as one expects; many business however, take some times before they realize a positive cash flow. This is normal.

Other information a company can gather from cash flows includes the "operating, investing, and financing activities" during a defined period; allowing a company to reconcile the amount of cash it receives from the beginning of the period an accountant calculates cash to the end of the period (Kieso, Weygandt, & Warfield, 2007). Having this information is valuable for many reasons. It allows a company to determine how much cash it will have available in the future; the company can estimate how much cash it may have and predict when that cash may be available. Most companies project what their cash flow will be from the time they begin offering a product or service, for defined periods of time. For example, a company may project how much their cash flow will be for five-year intervals starting from the time they offer a product or service for the next 10, 15 and twenty years out.

Sometimes receipts from credit transactions do not result in immediate cash; this is one reason why calculating cash flows is important. Knowing how much cash flow is available is important so a company can pay important debts, employees and pay for supplies important for conducting business. Other reasons for knowing cash flow include financing certain transactions including operating expenses, or investing in assets the company may need or require to conduct business. If a company is in the business of providing loans to others, it can only do so by knowing what its cash flows are from month to month, or it may realize a negative cash flow by lending too much money at any period of time. Cash flows originate from the sale of services and goods, or from the returns a company makes on interest gathered from loans or dividends. Cash goes out for various reasons; these include paying employees, paying taxes to the government or for sales and other obligations, and for general expenses associated with the cost of doing business.

Companies must also invest in assets, and in dividends. For most companies, cash flow remains in the negative for the early stages of a company's growth, or when a product is introduced to market (or service). Then as a product matures cash flows increase for period of time, and sometimes decline as demand for a product or service decreases. This cycle waxes and wanes depending on marketing for a produce and the demand for a product with time. If a product continuously generates revenue, cash flows may never wane.

If a company wants to grow, they have to know whether the cash generated by the company will be enough to sustain the company during expansion. Stockholders want to make sure the company is always generating enough cash to pay their dividends; naturally creditors want the company to pay off debts; and employees want to ensure their employer can pay off debts, and pay them for the work they do for the company. The cash flow statement reveals all of this company, essentially determining the viability of the company. Cash flow statements have a section outlining the operating activities, or cash acquired from the basic operation of the company. Financing and investing activities make up the other components of the statement. Cash flow statements are great for getting an overall big picture of whether a company is doing well or not for investors interested in helping a company grow or expand. Companies interested in merging with a company will also look at a cash flow statement for a quick glance at how well a potential partner may be doing. Other reasons to look at a cash flow statement include determining where a problem may be if a company seems to be short money.