How It's Used in Decision Making
Simply put, cash can make or break a company. A company could have plenty of accounts receivable, meaning that plenty of people owe it money. However, without cash, it is unable to meet its own debts. After all, you can't just tell someone you owe money to that he should go collect it from someone else who owes you money - that's not how the world works!
Instead, from the cash flow statement, a company can answer that central question - can this company make cash? If the answer is yes, the question then becomes one of how much. Additionally, it can also become a question of what to do with that money. If someone is managing a company that has managed to not yet procure positive cash flow, then the decisions should be focused around gaining cash. However, if there is a positive cash flow, then there are more decisions to make.
Here are some examples of decision-making:
- A company may choose to pay dividends with its profits, meaning pay the owner or owners. After all, people buy companies to make money.
- A company may also decide to invest its money in order to make more cash in the future. However, the cash flow statement should be analyzed in order to be sure that it can withstand the future debits that come with an investment that may prove to be less than successful.
- Or, a company can make other movements, such as paying off debt, buying a related company, or setting money aside for the future. Famously, several companies make the news for having billions of cash in reserve.
Example
Let's say that you own a small widget factory that has managed to post positive returns on its cash flow statement. However, the returns aren't all that impressive. In that case, you'd probably avoid spending them on a major capital expense, like buying another company, or making a major investment. Instead, you'd probably pay yourself a dividend or simply hold the money in reserve.
However, let's say that instead of a small return, your widgets sold like hotcakes! Suddenly, you have several tens of millions of dollars in excess cash! What do you do? Here, you might think that owners want the companies to pay a dividend, but that's not always true. After all, if you're doing such a good job making money, then there will be more encouragement for you to make even more money! As a result, companies that post a larger amount on their cash flow statements often invest the money in new concerns.
Lesson Summary
Companies can use the cash flow statement to make better decisions. A company that fails to post cash earnings should prioritize cash, while those companies that make smaller earnings often pay dividends or keep the cash in reserve. Meanwhile, companies that build up large sums of cash are encouraged to invest it further, either in their own operations or by acquiring another company.
