Question

Cash flow analysis is one of the most important processes that firms can conduct to keep the company running smoothly. For small businesses that may not be equipped to easily obtain short-term financing, cash flow analysis becomes an essential component for financial success.  

Respond to the following in a minimum of 175 words:

• Discuss the primary problem with cash flow analysis.
• Discuss two additional issues that makes cash flow analysis difficult.

Answer 1

Monitoring the cash situation of any business is the key. The income statement would reflect the profits but does not give any indication of the cash components. The important information of what the business has been doing with the cash is provided by the cash flow statement. Like the other financial statements, the cash flow statement is also usually drawn up annually, but can be drawn up more often. It is noteworthy that cash flow statement covers the flows of cash over a period of time.

• Cash Flow Statements help in knowing the liquidity / actual cash position of the company which funds flow and P&L are unable to specify.
• As the liquidity position is known, any shortfalls can be arranged for or excess can be used for the growth of the business
• Any discrepancy in the financial reporting can be gauged through the cash flow statement by comparing the cash position of both.
• Cash is the basis of all financial operations. Therefore, a projected cash flow statement will enable the management to plan and control the financial operations properly.
• Cash Flow analysis together with the ratio analysis helps measure the profitability and financial position of business.
• Cash flow statement helps in internal financial management as it is useful in formulation of financial plans.

Disadvantages of Cash Flow Statement

• Through the cash flow statement alone, it is not possible to arrive at actual P&L of the company as it shows only the cash position. It has limited usage and in isolation it is of no use and requires BL, P&L for its projections. Cash flow statement does not disclose net income from operations. Therefore, it cannot be a substitute for income statement
• The cash balance as shown by the cash flow statement may not represent the real liquidity position of the business because it can be easily influenced by postponing the purchases and other payments
• Cash flow statement cannot replace the funds flow statement. Each of the two has a separate function to perform.