Describe how the statement of cash flows helps investors and creditors perform each of the...

Question:

Describe how the statement of cash flows helps investors and creditors perform each of the following functions:

a. Predict future cash flows.

b. Evaluate management decisions.

c. Predict the ability to make debt payments to lenders and pay dividends to stockholders.

Annual Report & 10K:

The annual report, also referred to as a 10K for legal purposes, is a requirement for all public companies to publish on an annual basis. In it, investors will find a discussion from management on the company's performance as well as three financial statements: the income statement, balance sheet and cash flow statement.

Answer and Explanation:

a. Predict future cash flows. The statement helps investors and creditors predict future cash flows by helping to understand how the company generates its cash flows. In particular, analysts take net income plus depreciation, minus capital expenditures and net changes in working capital to calculate free cash flows.

b. Evaluate management decisions. The statement helps investors and creditors to evaluate management decisions, because it helps to see where cash flows are being generated. Most investors want a company that is generating positive cash flows, especially in operating cash flow. If it's not, the cash flow statement can help to understand where managers are going to make up for the cash shortfall: sell assets (cash flow from investment activities) or raise capital (cash flow from financing activities).

c. Predict the ability to make debt payments to lenders and pay dividends to stockholders.

The statement helps investors and creditors to predict the ability to make debt payments to lenders and pay dividends to stockholders, because it tells you 1) how much of the company's cash flow is coming from operations and 2) how much of that cash flow is going to dividends and lenders. If the company has a negative cash flow from operations balance it means it will probably have a difficult time paying lenders and stockholders unless it sells assets.


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Using the Statement of Cash Flows for Decision Making

from Accounting 101: Financial Accounting

Chapter 12 / Lesson 5
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