Question

Some accountants think that the Statement of Cash Flows is the most important financial statement. Do you agree or disagree with this? Why or why not? Hint - consider a business that is highly cyclical in nature like an ice cream shop!

Answer 1

I am agree with the statement, Cash Flow is very important financial statement along with Profit & Loss account and Balance Sheet. The importance of Cash Flow Statement can be understand with the following points in detail:

1. Short term planning

Cash Flow Statement is a very useful and important tool for the management of the company for the purpose of the short term planning along with keeping the control of cash. Every business entity has to keep a sufficient amount of liquid funds for meeting the various obligations, 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.

2. Provides information where money has been used

Another importance of Cash Flow statement is that there are many payments which the company pays but those payments are not reflected in the profit and loss statement of the company, whereas the same is required to be present in the cash flow statement. Thus the cash flow statement provides the detailed areas where the money is spent by the company.

For e.g. Payment of Loan.

3. For creation of excess cash

Every business organisation works 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 with the help of cash flow statement. On the other side, concentrating only on the P & L account makes it difficult to focus on creating cash.

4. Analyzing the cash planning results

Another importance of 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 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 budget with that of the present budget in order to asses that what will the cash requirement of the company in the future.

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 the long term financial planning as the growth of the company is dependent on that. Thus it shows key changes which are required for a company’s financial positioning and helps the management in prioritizing the important activities of the business.

6. 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 with this company 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 take the decisions accordingly.

The above points are also applicable on any cycling business.