Definition and Explanation of Cash flow statement

13/08/2008 21:18

Definition and Explanation of Cash Flow Statement

The purpose of the statement of cash flows is to highlight the major activities that directly and indirectly impact cash flows and hence affect the overall cash balance. Managers focus on cash for a very good reason―without sufficient cash balance at the right time, a company may miss golden opportunities or may even fall into bankruptcy.

The cash flow statement answers questions that cannot be answered by the income statement and a balance sheet. For example a statement of cash flows can be used to answer questions like where did the company get the cash to pay dividend of nearly $140 million in a year in which, according to income statement, it lost more than $1 billion? To answer such questions, familiarity with the statement of cash flows is required.

The cash flow statement is a valuable analytical tool for managers as well as for investors and creditors, although managers tend to be more concerned with forecasted statements of cash flows that are prepared as a part of the budgeting process.

cash flow statement can be used to answer crucial questions such as the following:

  1. Is the company generating sufficient positive cash flows from its ongoing operations to remain viable?
  2. Will the company be able to repay its debts?
  3. Will the company be able to pay its usual dividends?
  4. Why is there a difference between net income and net cash flow for the year?
  5. To what extent will the company have to borrow money in order to make needed investments?