The Cash Flow Statement(Part1of2)

To understand the true creation of shareholder value, we should not solely rely on accounting earnings/profits as it can be manipulated by overzealous aggressive top management. We need to be vigilant about accounting earnings vs cash.

The basic essential is that we need to appreciate Cash Flow Statement.

This article is of 2 parts- this Part 1 to understand the importance of cashflow statement and Part 2 to understand what’s in the Cash Flow Statement.

Basics:

Cash Flow Statements form an integral part of the financial statements. However, many readers tend to under-emphasize this statement, believing that the Income Statement and the Balance Sheet holds the key to their answers. There is a serious need to combine the use of Income Statement, Balance Sheet WITH the Cash Flow Statement to have a clear and better understanding of the business.

By understanding the cash flow statements, the readers can:

• Clearly see how the Board of Directors uses the cash of the company.
• Has the cash for that period in discussion increase or decrease?
• What cause the increase – too much investments in another entity or too much purchases of fixed assets for the long term success? [Don’t forget that Income Statement only shows the profitability of a business, a Balance sheet reflects only the assets and liabilities of the business at a point of time! Both Income Statement and Balance Sheet do not reflect the actual cash used by the business.]
• Management can manipulate accounting profits using creative accounting but cash flow statements reflect straightforward company’s transaction on cash basis.
• The cash flow statements tracks the MOVEMENT OF CASH through the business over a period of time ( say a 12 month period) [ In the Cash Flow Statement, it traces the cash balance at the beginning of the period, add or minus whatever involves the movement of cash to derive the ending cash balance.]
• Its shows how the business how much cash has been spent whether on its operations, investing and or financing activities
• Just imagine that a Cash Flow Statement is your own cash book where all the ins & outs were shown for a certain period of time.

Next article is on the basic understanding of what’s in a Cash Flow Statement.

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