A cash flow statement is one of the three primary financial statements that companies release on a regular basis. A cash flow statement shows where money is coming from and where it is going. If you are an investor or a potential investor in a company, this statement can provide you with valuable information, but it also has a few drawbacks, so understanding the advantages and disadvantages of cash flow will help you make better investing decisions.
If you are a small-business owner, tracking your cash flow is critical to your survival because you must be able to maintain adequate capital to pay your bills. Knowing your cash flow helps you arrange for credit during slow periods or helps you avoid paying large bills early that you don't have to until a later due date.
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Cash Flow Statements Show Changes
One of the advantages of the cash flow statement is that it provides you a detailed look at the changes in the amount of cash that a company holds over time. It is not a statement that provides you with absolute information such as a balance sheet or an income statement.
These documents show you a company's net worth at a specific time and profit performance during a specific period. A cash flow statement looks at whether the company is accumulating more cash than it once did or if it is losing cash during a specific period of time. This helps you get a broad view of the success of the company when combined with the other statements.
Looks at Growth Potential
Another benefit of using a cash flow statement is that it tells you whether the company has enough money to expand, according to Kotak Securities. Typically, when a company wants to expand, it needs cash. While companies will not always expand when they have cash, companies with large amounts of cash are usually financially stronger than those without.
The cash flow statement only provides information about where cash and cash equivalents are going to and coming from. It does not look at the asset holdings of the company.
Does Not Consider Future Growth
One of the potential disadvantages of the statement of cash flows is that it does not take into consideration any future growth. When looking at the statement of cash flows, you are essentially looking at information from the past business operations.
If the company is in the process of developing a ground-breaking piece of technology, it could be about to generate a large amount of cash. If you just look at the cash flow statement, you may not evaluate the future potential of the company correctly.
Difficulties Interpreting Data
Another potential problem with the statement of cash flows is that interpreting data may be difficult. The information on a cash flow statement is not necessarily easy to interpret and is one of the limitations of a cash flow statement. You can see where all of the cash flow is going, but you may not know if it should be going there.
For example, it may be difficult to gauge whether the company should be investing more in a plant or paying off debt. You have to take all of the information presented and make the best assumptions you can make.