Discuss why the statement of cash flows represents an important tool for the financial statement...

Question:

Discuss why the statement of cash flows represents an important tool for the financial statement user. Why is balance important between different financing decisions (e.g. stock issuance versus debt issuance)?

Cash Flow Statement:

Cash flow statement refers to a statement stating the entrance and exit of cash from the operations of the company. It is one of the required statement in the yearly statements of a company which shows the management of cash by a firm.

Answer and Explanation:

A cash flow statement is an important tool for users of financial statements because of the following reasons:

  • The cash flow statement conveys the status of cash and the level of liquidity maintained by the company.
  • The user measures the solvency of the company with the help of a cash flow statement.
  • The investments and operations of firms are also analyzed by interpreting information from cash statements.
  • It helps the users to make an investment decision in the company. A business with high liquidity attracts the attention of investors.

It is important to maintain a balance in the capital structure of the company that is in equity and external borrowing because relying more on any source will not be fruitful for a company. The acquisition of more debt in comparison to stock issuance creates a negative image of the company that the company does not have ample earnings to carry its operations. In contrast, when a company depends on equity, then it drops the opportunity to extract benefits of debt facility even after having the potential to acquire debt. Hence, it is recommended for a firm to have a balance among the two for the excellent utilization of funds.


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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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