Question

Please explain ?” Why are the income statement and balance sheet, by themselves, insufficient vehicles for assessing a company’s overall performance and financial standing? This is another way of asking, what information value is added by the cash flow statement?

Answer 1

Income Statement and Balance sheet serves many purposes but at the same time they lack in giving details about the flow of cash, data for short term planning and liquidity position.

This kind of information is provided by a Cash flow statement. It helps the management to understand the flow of cash throughout the period and places where cash is used.

We sometimes think that why a business is not able to grow, or shutdown, even though it earns more than average return. The reason lies in the cash position of a company which is important for survival of a business. A company having huge sales revenue may have negative cash Operating cash which can only be assessed by a Cash Flow Statement.

A cash flow statement helps management to take short term planning decision, like buying a machine, how much dividend to declare ?, what should be the credit terms with suppliers and customers ?, etc. A proper format of cash flow tells flow of cash by various sources such as finance, operations and Investments. The reason behind Cash balances is explained by a cash flow statement. It gives the management the information regarding the ability of a business to pay its current debts and the ability of a business to cease any investment opportunity. Management also use Cash flow for making predictions about future cash flows and future planning.

In a way A cash flow completes the Financial Statement with detailed analyses.