Why do some financial analysts and advisors consider the Statement of Cash Flows to be the most significant of the audited financial statements? How is the information presented in the Statement of Cash Flows different from the information presented on the Income Statement? Is it possible for an organization to incur a net operating loss for the year and have positive cash flow from operations? Why or why not? In the long run, is it more important for a business to have positive cash flows from its operating activities, investing activities, or financing activities? Why?
Although many owners believe that income statement should be focused as it shows the profitability of the business; the bankers, investors and strategic partners would pay attention to the statement of the Cash Flows as it provides an overview of in/outflow of funds of the business; making it easier for them to understand: the amount of cash that is being generated by the operations; the liquidity of the business; performance of the organization; the origin of the inflows and outflows of cash; and most importantly it also helps in understanding what the future cash flows might seem like (Lev and Li et al., 2010). It is easier to create some financial metrics that would lead to identifying the trend analysis of the finances of the businesses. This is very important for the decision makers to know the investing and financing activities.
Income statement represents information regarding the income and the expenses of the business; it shows a specific time and does not indicate solvency of business. On the other hand, statement of cash flows shows all the inflows and outflows of cash during the period. It also takes part of the income statement in order to show the sources of cash that has been used. A company that has net loss can still show positive cash flow; this can be explained by the depreciation expense (it tends to reduce the net income of the company) and accrual accounting (expenses are reported as incurred which is even before the payment of invoice) (Foster III and Mcnelis et al., 2012).
In particular, the company should have positive cash flows from operating activities; investors would always invest in business whose operating cash flow is positive so that they can guarantee the payment of dividends. The cash flow from investing activities cannot be sustained over long run; company grows by making investments and so there is negative cash flows (Ingram, 1994). And financing activities are dependent upon the cash generation from its core operations so operating activities should be positive.
References
Foster III, T., Mcnelis, L. and Smith, W. (2012). The Statement of Cash Flows: An Indirect to Direct Conversion Tool to Enhance User Understanding and Analysis. Journal of Accounting and Finance, 12 (2), pp. 94-119. [Accessed: 2 Sep 2013].
Ingram, R. (1994). Financial accounting. Cincinnati, Ohio: South-Western Publ., College Division.
Lev, B., Li, S. and Sougiannis, T. (2010). The usefulness of accounting estimates for predicting cash flows and earnings. Review of Accounting Studies, 15 (4), pp. 779-807. [Accessed: 2 Sep 2013].
