Question

Many small business owners focus on the cash balance in their bank accounts and may not use the statement of cash flows to analyze how their businesses are generating or using cash. Discuss what one piece of information is found on the statement of cash flows that is just as important as the bank balance (or more so) for the purpose of understanding the financial position of a company.

Answer 1

Bank book and Cashflow Statement

All the cash transactions wheather it is a cash receipt or a cash payment are recorded in the bank book. The balance of the bank book should be debit otherwise it can be said that the organisation has an issue with its liquidity even its existence can be in danger due to lack of cash. Now the purpose of the cash book is to record all the cash transactions of an organisation and to give the balance of cash in the bank account.

On the other hand the Cash flow statement supply the information regarding the cash inflows and outflows from different activities. Any organisation has three activities which are Operating activities, Investing activities and Financing activities. It can be said that the cash flow is a condensed version of Bankbook. Cause, any cash transactions which recorded in the bookbook comes to Cash flow statement also. But there is a bit difference between Bankbook and Cashflow statement. The transactions which are recorded in Bankbook are recorded into Cashflow Statement by dividing to the three categories of Activities according to the nature of the transactions.

The main purpose of the Cashflow statement is to supply the information regarding the cash inflows and outflows from the various activities. Its usefulness is far more important than the Bankbook.

Important information from the Cash flow statement

Cashflow statement provides the information of cash from different activities. Now we have to understand the activities. The Operating activities is the activity from which the organization earns revenue. It is the main activity for which the organization is formed. Let's take an example. Suppose a restaurant chain has earned revenue from the sale of foods and beverages and it's also has earned revenue from the investment it made into the common stock of an another company. Now, there are two type of revenue the restaurant chain has. One is it's sales revenue and another is it's dividend from investment revenue. But the restaurant is formed to sell foods and beverages this is it's main activity. Investment of money in other company is it's secondary activity.

On the other hand any investment made by the company or sell of any assets and income from any investment come under the Investing activity.

Any type of Financing transactions like issue of shares or debentures, payment of loans and dividend and interest come under Financing activities.

Now, among the three activities the most important activity is the Operating Activity. Cause, it is it's main activity for which the Company is formed.

In the Cashflow statement cash from operating activity is the most important piece of information which is much more important than mere a bank balance. To understand this let's take an example.

Suppose a company has negetive cash from operating activities and positive cash from investing and financing activities which leads to inflow of cash into the organization. The Bank book balance is debit or positive in this case. But this situation is indicating that the company has poor performance in its main activity. If this happen year after year then it can leads to the dissolve of the company cause its performance in its main activity is poor.

So, the information regarding the Cashflow from operating activity is very much important than the Bank balance cause through bank balance we cannot understand the health of the company or we cannot know how the company is doing in its main activity. But through Cashflow statement we can understand this issue easily. This is the piece of information which is far more important than Bank balance.