Question

1. How do banks, creditors, investors, key employees, customers, and the SEC each look at the statement of cash flows for a company, and what is each stakeholder group concerned about.

2.The statement of cash flows in essence shows accrual basis financial statements, except converted to cash basis. This this statement true or false? Why or why not?

3.What is the difference between the statement of cash flows, and the free cash flow concept?

Answer 1

1. Cash Flow Properties/importance for:

A. Banks: Banks are stakeholders in a company with respect to the credits (loans, cash credit, overdraft) they have provided or proposed to provide. So for the smooth recovery of the funds they are concerned with the cash flows companies are generating with their operations. Banks use various ratios like interest coverage ratio, debt coverage ratio for seeing the performance of the company and inflows company is generating. So the main utility of cash flows of companies for banks is to check the viability and smooth running of company and to assure themselves that credits which they have provided is going to be recovered over the term.

B. Creditors: Creditors represent the group with which the company performs its business transaction like purchase, receipt of service and utilities on the mode other than cash. So main concern of creditors with cash flow is how long it will take for the company to repay their dues. In general business practice credit transactions are done on the basis of 60/90 days (more or less) credit period and thereafter interest is charged on late payment of dues. So if the company is making enough cash from its outward transactions then it will be able to pay its creditors. So creditor groups look at the cash flows with a view of sufficiency of funds for timely recovery of their concurrent dues.

C. Investors: Investors invest their funds in the company with intent of ample returns. So the main concern of investors from cash flows of the company is:

• to have a clear picture of a company's ability to repay their capital invested.
• to judge whether the company is financially sound.
• to have an overview of how long company will perform.
• to know that what percentage return they are getting on the money invested.
• to know where the company spends it money and what are the sources of income of the company?
• that the money is being spend for the purposes it is authorized to.

D. Key Employees: Employees work with the company for salary and wages, so the prime concern of employees from the company is to know whether the company will be able to afford compensation and award salary and wages timely.

E. Customers: Customers are concerned with cash flow with respect to the timely delivery of their orders and fulfillment of trade contracts. So they look into the ability of company that company will be able to afford and fulfill their orders within time and with quality.

F. SEC: Securities and Exchange Commission of U.S. is responsible for protecting investors, maintaining fair and orderly functioning of securities markets and facilitating capital formation. SEC is concerned with the trade practices being carried out inside the company. SEC looks into that funds are being raised properly and they have been utilized in legitimate ways, so that investors interest are not prejudiced. So SEC is basically concerned with the source of inflows and manner and destination of outflows of the funds.

2. Cash Flows Accrual or Cash Basis:

Lets have a basic knowledge of the cash flow format:

There are two methods of preparing cash flow:

A: Direct Method (Presenting the cash fetched from activities)

B: Indirect Method (Starting from the net income from cash and non cash activities and then making adjustment to arrive on cash generated from all activities)

It is divided into 3 parts- Cash From Operating Activities, Cash From Investing Activities and Cash From Financing Activities.

Now Coming onto the point of your question:

Cash Flow is prepared to show the real cash inflow and outflow from the activities of company. Even if it is done from Direct or Indirect method, the Cash Flow Statement in essence show transactions on cash basis. So the statement that "The statement of cash flows in essence shows accrual basis financial statements, except converted to cash basis." is false. The reason for this is that Financial statement of a company is prepared on accrual basis that shows the profit which is not in cash. So to arrive at the real income of the company all non cash transactions of the period is being eliminated to prepare cash flow statement and to know the real cash inflow or outflow of the company. As per US GAAP the non cash items are presented by way of foot notes below the cash flow statement.

3. Difference between Statement of Cash Flow and Free Cash Flow:

Cash Flow statement is prepared in 3 parts to show:

Cash From Operating Activities,

Cash From Investing Activities and

Cash From Financing Activities.

Free cash flow is often defined as the cash flow from operations (or net cash flows from operating activities) minus the cash necessary for capital expenditures. Occasionally, dividends to stockholders are also deducted. Capital expenditures can be seen as the amounts spent to acquire or improve a company's fixed assets.

So as the cash flow statement presents the cash outflow as well as cash inflows from investing and financing activities too, on the other hand Free Cash flows does not account for cash inflows from Investing and Financing activities but only account for capital expenditures(part of investing activities).