Question

ROOM FOR DEBATE

• Debate 7‐1 Usefulness of the Statement of Cash Flows versus the Income Statement

  According to SFAC No. 1, financial statements should provide information that is useful for investors’ decision making. Paragraph 37 of SFAC No. 1states that financial reporting should provide information to help users assess the amounts, timing, and uncertainty of prospective cash flows. Paragraph 43 of SFAC No. 1 states that the primary focus of financial reporting is providing information about an enterprise’s performance based on measures of earnings and earnings components.

  Team Debate:

  Team 1:

  Present arguments that the statement of cash flows, not the income statement, is the most important financial statement to prospective investors.

  Team 2:

  Present arguments that the income statement, not the statement of cash flows, is the most important financial statement to prospective investors.

Answer 1

Team 1’s arguments – The statement of cash flows is the most important financial statement to prospective investors because of the fact that the statement of cash flows shows how much actual cash a company is generating. The statement of cash flows takes care of non-cash revenues and expenses by making appropriate adjustments for them. Investors are often interested in knowing a company’s free cash flow as free cash flow is an important financial metric for investors. Investors often use free cash flows in the DCF (discounted cash flow model) to compute a company’s intrinsic value and then determine whether the company is overvalued or undervalued.

Team 2’s arguments – Income statement is the most important financial statement to prospective investors because of the fact that income statements reveals the ability of a business to generate a profit. Businesses and corporate entities create value for investors by generating profits and prospective investors use the income statement to gauge the company’s ability to generate profits today as well as in future. Operational aspects of a business are sometimes the most important aspects for a company and this information can be gleaned by investors only from the company’s income statement.