You don’t need to overcomplicate things, just know that a cash flow statement is nothing but just a financial tool or statement that is there to check the inflow as well as the outflow of the cash in an organization or company. Simple! But what’s the need for such a thing? Well, there are many reasons, but the main one is to simply check the financial health of a company in one quick look. And if you still want to know what’s the positive side of checking a cash flow statement and what it hides, then keep on reading today’s post. Here we have put together the advantages and disadvantages of a cash flow statement, so, let’s get to it.
Advantages of Cash Flow Statement
1. Checking Up on Profitability and Liquidity
For starters, you see, a cash flow statement (CFS) is nothing but a tool that shows how much cash a business brings in and how much it spends, simple as that. That’s precisely how it helps the business figure out its liquidity and financial health, or if it can pay its short-term debts, you know? That is the very reason why everyone involved, from managers to investors, can get a real-time picture of whether a business can pay its bills, keep the lights on, and even start new projects.
2. Mastering Cash Management
When it comes to not only keeping track of the spending but also managing the funds in the best possible way, well, again, CFS aka Cash Flow Statement is what comes in super handy. How it does that? Well, by keeping an eye on how cash moves, businesses can easily guess and plan for their financial future. When the CFS sees that there will be a lack of cash, managers can get some money together before things get bad. And what if there’s extra money lying around? So, that’s a chance to spend that money and make it work harder, you know?
3. Sizing Up the Capital Cash Balance
Capital cash balance is super important for every company out there to check back regularly, and that’s precisely where Cash flow statements again make it super easy. Based on this quick look-see, firms can make smart decisions like investing in new projects or giving dividends to owners when they know whether the amount is too much, too little, or just right. But what if the money is a bit tight and it is not looking good in the future to shell out that money like crazy? What then? Well, then it might be time to look for money from somewhere else, that’s how simple it is.
4. Boosting Planning and Teamwork
The CFS doesn’t just keep the money in order, it’s also a powerful tool for improving planning and coordination across the whole business. Well, if you are new to this CFS thing, then it might sound a bit out of subject, right? But the thing is, CFS shows all the cash flows, which helps teams across the company make sure that their budgets and money moves work with each other. That’s what we meant when we mentioned teamwork.
5. Outshining Accrual Basis Accounting
Accrual basis accounting keeps track of income and costs when they happen on paper, but the cash flow statement (CFS) keeps things real by tracking real money coming in and going out. The CFS is a more practical way to figure out how liquid a business is because it focuses on real cash. There are times when the non-cash numbers in accrual accounting, like depreciation, can make it look like a company is doing better financially than it really is.
6. A Reality Check for Financial Statements
The cash flow statement (CFS) is another way to authenticate and verify other financial records, like the balance sheet and income statement. Though there are other aspects to just this, we won’t go super in-depth about that so just get this: it’s easier to spot mistakes or signs of financial fraud when cash flows are lined up with stated numbers.
Disadvantages of Cash Flow Statement
1. Doesn’t Fully Capture Profitability
One of the major considerations with a Cash Flow Statement (CFS) is that when detailing cash movements it actually doesn’t reveal a company’s profitability. Surprised a bit? Yes, that’s how it is. Depreciation and amortization are excluded because it focuses on cash transactions. And that is precisely why it doesn’t reveal the company’s underlying economic performance.
2. Needs Backup from Other Financial Statements
You can’t just have the CFSs of a company and understand where the financial health of that company stands, it doesn’t work like that. Sure, you can get a little bit of an idea of that, but you’d still be far away from the real picture, you know? That’s the very reason why you need the balance sheet and income statement along with CFSs to form a conclusion on your own and a correct one. The balance sheet shows assets, liabilities, and equity, whereas the income statement shows revenues and expenses. So, that will really be helpful for you.
3. Stuck in the Past
When you are looking at a cash flow statement, you aren’t actually looking at the current financial performance of the company, it is actually based on historical data, so you are kinda reading the history of the company, or at least that’s what it feels like. But why is that? Well, you must understand that companies and businesses out there need historical data to forecast and plan, but fast-changing markets make it hard to keep track of trends. So, do not mix things up, and always know that CFSs aren’t the present report card of an organization.
4. Easy to Misinterpret
Sure, we can’t deny that it is possible that strategic investments aiming for long-term growth are responsible for poor cash flow, thus it should not be taken as a warning flag. However, a lot of money coming in isn’t necessarily a sign of success, it could be the result of selling off assets all at once, which isn’t really sustainable. So, you shouldn’t just jump to assumption, it is better to dive even a bit deeper.
Conclusion
All in all, if you know what to look for in a cash flow statement, and how to actually analyze it properly, it can really be a great tool to check the financial health of a company. But you shouldn’t be judging based on just that, consider other aspects as well.
