Merits and Demerits of Cash Flow
We described Cash Flow Facts as the merits and demerits of cash flow discussing the cash flow statements as a whole.
The Merits Are As Follows:
- Cash Flow aids in capital planning, which is concerned with the decisions made with regard to capital expenses.
- The cash flow statement designates a firm’s profitability and liquidity. The latter refers to the aptitude of a firm to meet its financial responsibilities at the time it is required to do this. The statement indicates a firm’s financial health within a specified time; it makes it possible to ascertain whether the firm will be profitable.
- This indicates whether a firm has an inadequacy of cash or whether some of its cash is lying idle or if it is in excess.
- It helps in planning and forecasting, further promoting the administration of finances within the company.
The Disadvantages Of The Cash Flow Statement Are As Follows:
- It does not show net income. Consequently, it requires an observer to refer to other financial statements so as to gain more insight into the company.
- The statement only shows the cash and cash equivalents. Therefore, it only provides the cash aspect specific firm. It is impossible to determine the profits and losses of the company by just consulting the cash flow statement alone.
What is cash flow analysis?
Cash flow analysis entails probing both the inflows and outflows of cash into and out of the company within a specific period. Different activities result in the movement of money. These include investing, financing, and operating expenses. This information is contained within a cash flow statement. In this regard, the process can also be regarded as cash flow statement analysis.
Cash flow analysis example
Consider the information for a company called UP which deals in computer hardware and software. The following is a summary of the first quarter cash flow regarding operating activities.
Amount for 1st quarter
|Depreciation and amortization||$40,000|
|Decrease in inventory||$67,000|
|Increase in accounts payable||$5,000|
|Gain or loss on sale of equipment||$288,00|
|Increase in accounts receivable||$78,000|
|Decrease in income payable||$7,900|
Table 1: Cash flow statement for operating activities
From the example above, the net cash from operating activities is negative because the cash outflows are greater than inflows. Performing cash flow analysis is predicated by an understanding of the constituents of a cash flow statement.
A decrease in inventory implies that the firm sold more items from its warehouse (inflow). If the company had spent more money purchasing additional raw materials, this would constitute an increase in inventory, thereby making it an outflow. The increase in accounts payable reflects that the company increased its credit by $5,000. As such, this form of debt is considered an inflow. The gain or loss on sale of equipment relates to the amount by which the cost of used equipment exceeds or is lower than the initial buying price. If it is greater, then it is categorized as an inflow. However, in this case, the figure was lower by $288,900. As such, it was an outflow.
Importance of Cash Flow Analysis
Cash flow analysis of numerous statements helps business people identify trends and understand the money flowing into and out of a company for effective planning. It helps traders establish the amount of cash that a firm has, thereby painting an accurate picture of its financial health.
This is the process of examining a cash flow statement to determine the money flowing into and out of a company, business, or project.
This is a breakdown of a company’s earnings and expenditure by looking at the cash flow statement. The result is a clearer picture of the money flowing in and out of a company’s accounts.