From an external investor's perspective, which is most important for determining a firm's overall financial health:...

From an external investor's perspective, which is most important for determining a firm's overall financial health: the firm's income statement, balance sheet, or cash flow statement? Justify with three reasons. Would your answer differ if you were an internal manager of the firm? Explain. 300 words minimum

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Expert Solution

The cash flow statement is the most important financial statement, for the investor in the business as it determines the amount of cash available in the business as cash is king in a business. Although the balance sheet gives a view of the assets and liabilities with a business at a particular point of time, it does not indicate how much a business is profiting. The balance sheet can reveal aspects that can help better the financial position of the firm. It shows the position of the company at a given point of time, not in a particular period.

The income statement is subject to manipulation, income can be overstated and expenses understated to show grater profits.

The free cash flow allows a company to be able to pay dividends, repay its debts, buy back its stock and also make new investments to facilitate future growth.

The cash flow statement provides a clear picture of the cash inflows and the cash outflows. The cash flow statement shows 3 types of cash flows:

Operating cash flows indicate the cash flows related to revenues and expenses of the firm.
Investing cash flows are the investments made in long-term assets
Financing cash flows are related to stockholders’ equity like payment of dividends.

For the internal users , the income statement is the most important financial statement.The income statement shows the ability of the business to generate profit and the management is responsible for fine tuning the operations of the business to generate higher profits and income. It shows the top line as well as the bottom line. There is also possibility of comparison of sales and expenses form one period to the another. The business can take better decisions about growth by looking at the sales and expenses.

jeff jeffy answered 1 year ago

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