As a complement to the balance sheet and the income statement, the statement of cash flows is an informative statement for analysts for the following reasons:

• Analysts who understand the types of information this statement presents and the kinds of interpretations that are appropriate find that the statement of cash flows reveals information about the economic characteristics of a firm’s industry, its strategy and the stage in its life cycle.

• The statement of cash flows provides information to assess the financial health of a firm. Analysts increasingly recognize that cash flows do not necessarily track income flows. A firm with a healthy income statement is not necessarily financially healthy, and vice versa. Cash requirements to service debt, for example, may outstrip the ability of operations to generate cash.

• The statement of cash flows highlights accounting accruals, which can provide insight into the overall sustainability and quality of a firm’s reported earnings.

The primary purpose of the statement of cash flows is to provide financial statement users with information about a firm’s cash receipts and payments. Implicit in this objective of providing information on the net cash flows of a period is reporting the sources and uses of cash that cause the change in the cash balance on the balance sheet. This is accounting in its simplest form: Beginning Cash _Cash Receipts _ Cash Expenditures _ Ending Cash Balance

An understanding of a firm’s cash flows is an integral part of each of the six steps in financial statement analysis discussed in Chapter 1 These are:

Identify the Economic Characteristics of a Business

Identify the Strategy of the Firm

Adjust the Financial Statements for Nonrecurring, Unusual Items

Analyze Profitability and Risk

Prepare Forecasted Financial Statements

Value the Firm

Required

Discuss how the statement of cash flows integrates into the above six steps of analysis.

Answer rating: 100% (QA)

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