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 Cash Flow Statement A Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.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 operating activities is crucial 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 investing 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 finance is crucial 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
Let us discuss step by step the importance of cash flow statement with examplesCash Flow Statement With ExamplesA cash flow statement is a financial statement that provides a detailed analysis of how the cash inflows and outflows happened because of its operations and any external investment and financing in the given accounting period. –
#1 – Short Term Planning
The Cash Flow Statement is considered to be a useful and vital tool for the management of the company for the purpose of short term planning, along with keeping 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 expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit., 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 has the profits, but after payment of the 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 the 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 the 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 budgetCash BudgetCash budget refers to cash inflows and outflows estimations made by a company's management over a given period to evaluate whether the business has adequate cash & cash equivalents to meet its operational needs in the coming future. with that of the present budget in order to assess 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 would be $10,000, but the actual was $20,000. So such a variance between expected and actual should be identified by the company, and the 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 vital changes that are required for a company’s financial positioning and helps the management in prioritizing the crucial activities of the business.
For Example, projected cash flow helps the management of the company in identifying the possibility of long term debtLong Term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability. 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 make the decisions accordingly.
For Example, if there is a surplus of cash and funds are lying idle, then the company can invest surplus cash, or if there are 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 capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)" 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 of 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 cash by reducing the time taken for collecting the amount from debtors and delay in buying inventory for preserving cash, etc.
This article has been a guide to Cash Flow Statement Importance. Here we discuss the top reasons why cash flow statement is vital, 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 –