Question

“For those brave enough to act effectively now to stabilise and protect your business and maintain liquidity, opportunity will come.” Explain whether the Statement of Cash Flows is able to illustrate the ‘liquidity’ of an entity to its users and provide ONE recommendation how companies can maintain liquidity during this pandemic. Your answer should be between 200-300 words MAX.

Answer 1

A Cash flow statement is one of the important parts of financial statement provided by an organisation. It helps in understanding the cash flows from operating, investing and financing activities. The income statement of an organisation is prepared based on accrual basis and hence it does not help in understanding the cash movements during the year. A cash flow statement helps in understanding movement of cash during the year and helps in taking informed business decisions. It helps in measuring the liquidity of the company.

The cash flows from operating activities is calculated by adding non cash expense to net income and then adding back or deducting current assets and liabilities. Higher current assets lead to cash outflow and higher current liabilities leads to cash inflows. Similarly lower current assts leads to cash inflow and lower current liabilities leads to cash outflows. The cash flows from operating activities are very important to firm since it helps in generating cash to invest in fixed assets and repay debts or pay dividends to shareholders.

During the current ongoing pandemic maintaining liquidity has become very important. Since the business activities are almost freezed the firm has to incur cash operating costs. Hence a firm should have enough cash to maintain the business running. The firm can review its current assets and see if it can be converted to cash on immediate basis. If a firm is holding marketable securities the firm can maintain liquidity during current crisis by selling the same.