Uses of the cash flow statement

Some of the main areas where IAS 7 should provide information not found elsewhere in
the financial statements are as follows.

(a) The relationships between profit and cash can be seen clearly and analyzed
accordingly.
(b) Cash equivalents are highlighted, giving a better picture of the liquidity of the
company.
(c) Financing inflows and outflows must be shown, rather than simply passed
through reserves.

One of the most important things to realize at this point is that it is wrong to try to assess
the health or predict the death of a reporting entity solely on the basis of a single
indicator. When analyzing cash flow data, the comparison should not just be between
cash flows and profit, but also between cash flows over a period of time (say three to
five years).

Cash is not synonymous with profit on an annual basis, but you should also remember
that the 'behaviour' of profit and cash flows will be very different. Profit is smoothed out
through accruals, prepayments, provisions and other accounting conventions. This does
not apply to cash, so the cash flow figures are likely to be 'lumpy' in comparison. You
must distinguish between this 'lumpiness' and the trends which will appear over time.
The relationship between profit and cash flows will vary constantly. Note that healthy
companies do not always have reported profits exceeding operating cash flows. Similarly,
unhealthy companies can have operating cash flows well in excess of reported profit. The
value of comparing them is in determining the extent to which earned profits are being
converted into the necessary cash flows.

Profit is not as important as the extent to which a company can convert its profits into
cash on a continuing basis. This process should be judged over a period longer than one
year. The cash flows should be compared with profits over the same periods to decide
how successfully the reporting entity has converted earnings into cash.

The advantages of cash flow accounting are as follows.

(a) Survival in business depends on the ability to generate cash. Cash flow accounting
directs attention towards this critical issue.
(b) Cash flow is more comprehensive than 'profit' which is dependent on accounting
conventions and concepts’ FARD
(c) Suppliers and lenders are more interested in an entity's ability to repay them than in its
profitability. Whereas 'profits' might indicate that cash is likely to be available, cash
flow accounting is more direct with its message.
(d) Cash flow reporting provides a better means of comparing the results of different
companies than traditional profit reporting.
(e) Cash flow reporting satisfies the needs of all users better.
(i) For management, it provides the sort of information on which decisions should be
taken: (in management accounting, 'relevant costs' to a decision are future cash flows);
traditional profit accounting does not help with decision-making.
(ii) For shareholders and auditors, cash flow accounting can provide a satisfactory
basis for stewardship accounting.
(iii) As described previously, the information needs of creditors and employees will be
better served by cash flow accounting.
(f) Cash flow forecasts are easier to prepare, as well as more useful, than profit
forecasts.
(g) They can in some respects be audited more easily than accounts based on the
accruals concept.
(h) The accruals concept is confusing, and cash flows are more easily understood.
(i) Cash flow accounting should be both retrospective, and also include a forecast for the
future. This is of great information value to all users of accounting information.
(j) Forecasts can subsequently be monitored by the publication of variance statements
which compare actual cash flows against the forecast. hapter Roundup
Cash flow statements are a useful addition to the financial statements of companies
because it is recognized that accounting profit is not the only indicator of a company's
performance.
Cash flow statements concentrate on the sources and uses of cash and are a useful
indicator of a company's liquidity and solvency.

Disadvantages
The main disadvantages of cash accounting are essentially the advantages of accruals
accounting (proper matching of related items).
There is also the practical problem that few businesses keep historical cash flow
information in the form needed to prepare a historical cash flow statement and so extra
record keeping is likely to be necessary.