Why Has Cash Flow Become Such An Important Measure of a Firm's Financial Condition?
The monies that represent total earnings of an investment before depreciation, non-cash charges and amortization are known as cash flow. Thus, it is the amount of net cash generated by a business or investment during a specific period and at a certain time. Globally, business is regarded as the buying and selling of commodities or the exchange of a certain value between two or more parties making cash the needed asset for involvement in the monetary system.
Significantly, in order to survive, businesses ought to generate positive cash flow, hence; its long-term cash inflows must exceed in the end its long-term cash outflows. When there is a transfer of money to another party by a business, an outflow of cash is experienced, but when there is a direct transfer of money into the business’ possession then a cash inflow is experienced (Beaver, 48).It is important to note that cash flow can be generated from a numerous number of sources and equally essential for a company’s continued operation. Cash inflow mostly emanates from sales, loans, wages, revenues and salaries while cash outflow is commonly emanates from the investments and expenses. Moreover, due to the reason that cash is the important factor through which a business can only thrive, analysts consider cash flow to be a trivial monetary statistic. Businesses with increased cash flow are considered to be takeover targets since the acquiring firms are assured of pay off with regard to costs of acquisition through cash. Again, when there is an increased cash flow in a business, then there is a better chance of paying off service, investments in new assets, dividends and minimal debts as there are more funds available (Dechow, 54).
Consequently, a firm’s accounting practices on the other hand become influenced by the reported net income. It is through reduced income that more cash and lower taxes are realized; hence, the same principles of accounting practices that eradicate net income can be used to heighten cash flow. Research also shows that a business with huge quantity of new investments with matching high depreciation charges may report pessimistic earnings, but at the same time exhibit, large cash flows to purchase new resources and examine debts. It is thus significant to maintain a more positive net cash flow always, as it is the core of every business (Bernstein 78).
Beaver, William H., Financial reporting: An accounting revolution, Prentice Hall, Englewood Cliffs, NJ, 1981. Print.
Bernstein, Leopold A., Analysis of financial statements, 3rd ed. Dow Jones-Irwin, Homewood, IL. 1990. Print.
Dechow, Patricia M., Accounting earnings and cash flows as measures of firm performance: The role of accounting accruals, Ph.D. thesis, University of Rochester, Rochester, NY, 1993. …