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Boundless Accounting
Detailed Review of the Statement of Cash Flows
Cash Flow Accounting
Accounting Textbooks Boundless Accounting Detailed Review of the Statement of Cash Flows Cash Flow Accounting
Accounting Textbooks Boundless Accounting Detailed Review of the Statement of Cash Flows
Accounting Textbooks Boundless Accounting
Accounting Textbooks
Accounting
Concept Version 7
Created by Boundless

Importance of Cash Flow Accounting

The statement of cash flows provides insight that the balance sheet and income statement do not, particularly in regard to a company's cash position.

Learning Objective

  • Summarize why cash flow accounting is important


Key Points

    • Without positive cash flow, a company will not be able to meet its financial obligations, thereby leading to a cash crunch or bankruptcy.
    • Cash flow is the movement of money into or out of a business, project, or financial product.
    • The statement of cash flows is a valuable reporting tool for managers, investors, and creditors.
    • Being profitable does not necessarily mean being liquid.

Terms

  • cash flow

    The sum of cash revenues and expenditures over a period of time.

  • liquidity

    An asset's property of being able to be sold without affecting its value; the degree to which it can be easily converted into cash.

  • net income

    Net income also referred to as the bottom line, net profit, or net earnings is an entity's income minus expenses for an accounting period.


Full Text

Importance Of Cash Flow Accounting

Cash flow is the movement of money into or out of a business, project, or financial product from operating, investing, and financing activities. It is usually measured during a specified, finite period of time, or accounting period. The measurement of cash flow can be used for calculating other parameters that give information on a company's value, liquidity or solvency, and situation. Without positive cash flow, a company cannot meet its financial obligations .

Cash Flow

Cash

Management is interested in the company's cash inflows and cash outflows because these determine the availability of cash necessary to pay its financial obligations. In addition, management uses cash flow for the following:

  • To determine problems with a company's liquidity
  • To determine a project's rate of return or value
  • To determine the timeliness of cash flows into and out of projects, which are used as inputs in financial models such as internal rate of return and net present value

Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash even when it is profitable. Cash flow is often used as an alternative measure of a company's profitability when it is believed that accrual accounting concepts do not represent economic realities.

For example, a company may be profitable but generate little operational cash (as may be the case for a company that barters its products rather than selling for cash or when its accounts receivable turnover is long). In such cases if needed, the company may derive additional operating cash by issuing shares, raising additional debt finance, or selling its assets. In addition, cash flow can be used to evaluate the "quality" of income generated by accrual accounting. When net income is composed of large non-cash items, it is considered low quality.

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