The importance of cash flow statement is that it is used to measure the cash position of the business i.e. the inflow and outflow of cash and cash equivalents in the business for an accounting year and it also helps the business to know the availability of cash in their business.
Why is Cash Flow Statement Important?
Cash Flow Statement importance is that it measures the cash inflows or cash outflows during the given period of time. Such details of the cash position of the company can not only help the company or the financial analyst to plan for the short term or long term but also in analyzing the optimum level of cash and working capital needed in the company.
There are three categories under which the cash sources and the uses of the cash are divided which include:
- Cash flow Statement from the operating activities is important as it focuses on cash flows from the main activities of the business like selling and buying of the merchandise, provision of the services, etc.
- Cash flows Statement from the investing activities is important because it provides details of purchase and sale of the capital assets of the company i.e. the assets having a useful life of more than one year as per the balance sheet of the company.
- Cash flows Statement from the financing activities is important as it considers the stock purchase or sale by the company and any other proceeds or payments with respect to the debt financing. Thus they are the section in the cash flow of the company which reflects the net flows of cash of the company which is used for the funding.
Importance of Cash Flow Statement (with Examples)
Let us discuss step by step the importance of cash flow statement along with practical examples –
#1 – Short Term Planning
Cash Flow Statement is considered to be a useful and important tool for the management of the company for the purpose of the short term planning along with keeping the control of cash. For meeting the various obligations, every business entity has to keep a sufficient amount of liquid funds so that as and when the requirement arises it can pay the same. Thus the cash flow statement helps the financial manager in projecting the flow of the cash in the near future by using the past data of the cash inflows and outflows.
For Example, The company needs the cash for meeting the various obligations that could arise in the near future like payment of the debts, various operating expenses, etc.
#2 – Provides the Details where the Money is Spent
Another importance of the Cash Flow statement is that there are different payments which the company makes and are not reflected in the profit and loss statement of the company whereas the same is present in the cash flow statement. Thus the cash flow statement provides the detailed areas where the money is spent by the company.
For Example, If the company has the loan and it is paying off the principal amount back to the bank, then, in that case, the payment will not get reflected in the Profit and loss statement of the company whereas the same will be available in the cash flow statement. There might be a situation where the company is having the profits but it after payment of principal amount it has no funds to pay off its obligations. Such situations can be identified using the cash flow statement.
#3 – Creating Excess Cash
Every business enterprise runs for the motive of earning profits. The profit helps in creating the cash but there are other ways as well which helps in creating the cash in the company. These ways can be identified and implemented by focusing on the cash flow statement. On the other hand, concentrating only on the P & L account makes it hard to focus on creating cash.
For Example, the excess cash can be created if the company can collect the receivables from its customers faster if the company uses the inventory in an efficient manner, etc
#4 – Revealing the Cash Planning Results
Another importance of cash flow statement is that it helps companies in analyzing the extent to which the cash planning of the company became successful as the actual results using can be compared with the projected statement of Cash Flow Statement or the Cash budget. The results will then help the company to take the measures accordingly. Thus it helps the company in comparing the past assessments’ cash budget with that of the present budget in order to asses that what will the cash requirement of the company in the future.
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.
#5 – Long Term Planning
This is another importance of the cash flow statement that it helps the management in making the long term planning of the cash. It is necessary for the company to make long term financial planning as the growth of the company is dependent on that. Thus it reveals key changes that are required for a company’s financial positioning and helps the management in prioritizing the important activities of the business.
For Example, a 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.
#6 – Knowing the Optimum Level of Cash Balance
The importance of the Cash Flow Statement is that it helps the company in ascertaining the Optimum level of Cash Balance. It is necessary for the company to determine the optimum level of Cash Balance because this firm can know whether the funds of the company are lying idle, or there is a shortage of cash or the funds are excess. After knowing the actual cash position the management of the company can take the decisions accordingly.
For Example, if there is a surplus of the cash and funds are lying idle then the company can invest surplus cash or if there are the deficit funds then it can take the decision to borrow the funds from outside in order to overcome the deficit situation.
#7 – Helps in Analyzing the Working Capital
Working capital is the component of the cash flow from the operations that can influence the cash flow of the companies. Thus the investors should have awareness about the working capital movement in the company.
For Example, the company can preserve its cash by increasing the time for paying the bills, it can increase the inflow of the cash by reducing the time taken for collecting the amount from debtors, and delay in buying inventory for preserving cash, etc.
This has been a guide to Cash Flow Statement Importance. Here we discuss the top reasons why cash flow statement is important including short term & long term planning, working capital analysis, understanding optimal cash and more. You may also learn more about Accounting from the following articles –