The Statement of Cash Flow Is Not Redundant and Necessary for Investment Decision Making

Introduction The pick outr of Dowlais Iron Comp all, made a new pecuniary disceptation called comparison balance sheet, in 1863 to explain the reason for the inability to invest was due to the h sure-enough(a)ing of as well much inventory, despite the gain ground made. This was the beginning of the bills in take to the woods educational activity, which was subsequent made compulsory by the pecuniary be Standard Boards (FASB) at a lower place Generally Accepted Accounting Principles (GAAP). This step was followed by International Accounting Standard Boards (IASB) when they issue IAS 7 specie campaign tilt.The cash come controversy only reported transactions that took place by the determination of cash or cash equivalents, and discarded anything that was recorded on assemblage basis in Balance Sheet (Statement of Financial Position) and the Profit and mischief Statement (Statement of Comprehensive Income). The construction of the monetary resource go Statement i s divided up into three cash lead from operate, investiture and financing activities. With 2 approaches in constructing currency carry Statement direct and indirect approach, the difference is essentially on the construction of the first part, operating activities. currency flow from operating activities be cash flow from principal revenue-producing activities of the familiarity and other activities that argon non investing or financing activities. In using the direct rule approach, it would have to run low from scratch what are the cash receipts and cash payments made during the period, while the indirect method approach would start with the earnings before tax figure and later, adjustments are made, i. e. depreciation, emergence or accrue in inventories, receivables, payables, etc.The other two activities (financing and investing) remain the same regardless of methods manipulationd. pay activities are activities that result in changes in the size and composition of the rectitude capital and borrowings of the enterprise. For example, the emergence of the clubs shares, payment of divid residuals, borrowings, etc. With regard to the investing activities, it consists of any activities of investiture for capital assets, financial markets, and even operating subsidiaries.Although the existence of the bullion Flow Statement is considered quite new in the accounting institution (which starts around 1490s by Luca Pacioli, that was called bookkeeping), it is agreed that there are a lot of benefits with the presence of the currency Flow Statement. This position paper leave touch on a couple of them just to be degenerate on the topic, that is The Statement of Cash Flow is not Redundant and unavoidable for Investment Decision make. Cash Flow Statement as a Tool for Investment DecisionThere are ways and balances that we could map to m the solvency and liquidity of a family, using the information from the Balance Sheet (Statement of Financi al Position) and the Profit and Loss Statement (Statement of Comprehensive Income). However, with the presence of Cash Flow Statement, it is made easier and much logic. The first dimension would be the Operating Cash Flow Ratio which could be derive from the following verbalism Cash Flow from surgical ope proportionalityns ? Current Liabilities This ratio would give the trace as to whether or not the smart set is able to repay their current debt with the use of the cash from operating activities.This ratio is slightly similar to the Current Ratio, precisely the use of Cash Flow from Operations to replace Current Assets is precisely more logical to measure the liquidity, because the Current Asset includes Inventories and Receivables which are not of the high liquidity compared to cash. The investors can overhear a reasonable and justifiable decision based on this ratio, simply because it gives a recrudesce overtake of liquidity than the Balance Sheet (Statement of Financi al Position). The second ratio that could do investors decision reservation is the Price/Cash Flow Ratio.Even though this ratio is not widely use as the Price Earnings Ratio, this ratio is often considered as the better indication of the companys value. This mainly was due to the formula itself, which the Earnings per Share in the Price Earnings Ratio is changed to the Operation Cash Flow per Share. With this change, the value of the company relies on the cash flow from the principal revenue-producing activities, and not the Net Income which was derived on accrual basis, which the revenue and xpenses whitethorn or may not have been received and paid. With the information from Cash Flow Statement, investors are able to make a wiser decision as to valuation of the companies because the cash is of the same importance as the profit, and sometimes may be regarded as more important. The next ratio is to help in measuring the solvency of a company, it is the Cash Flow from Operations /Average fundamental Liabilities Ratio. From the name itself, we can figure that the formula would look like beneath Cash Flow from Operations ?Average Total Liabilities As menti hotshotd, this ratio is to measure the solvency of the company, similar to Total Debt/Total Assets Ratio as some(prenominal) are to know the ability of the company to pay its debts. However, this ratio is better in terms of that it measures for the whole period, and not at a contingent of time. To explain this, know that the cash flow from operations are generated from the start of the period until the end of the period, and it uses the average of native liabilities which does not focus on that point of time only.On the other hand, the Total Debt/Total Assets Ratio uses the total assets and total debts at the end of the period, the ones reported on balance sheet. Thus, one might increase their inventories or promote credit cut-rate sales towards the end of the period, just to boost up the total assets figure, which later would give the indication the company has the ability to pay its debt, due to the high total assets figure. isolated from these ratios that are derived from information in the Cash Flow Statement, the elements in the statement itself can be helpful for investors to make decisions, without even the need to reckon any ratio.For example, a company may be having a damaging total cash flow(total outflow), hardly if the cash flow from operating activities is supreme, it may still be a in effect(p) sign, as the negative cash flow is derived from the investing or financing activities. If the negative cash flow comes from heavy investing and causes a negative flow from investing activities, it may still be a good sign simply because the company might be considering an expansion in the prox.Thus, the elements in the Cash Flow Statement itself can give information for the investors to make decisions, without even the grate of computing ratios. Overall View of the c ompanionships Activities Before loo business leader at the future perspective of the company, which we have discussed earlier on how Cash Flow Statement is very helpful in making investment decision, the investors are more likely wanting to know the financial management of the company. Having a good future perspective may not always give profit to investors, if there is a bad financial management.With the elements laid out with such(prenominal) organization in the Cash Flow Statement, the investors would have a coup doeil or overview of the companys activities throughout the year, what decision have they(company) made, what are the odds for the company paying the dividends, etc. As mentioned previously, the total cash flow may not necessarily give the right interpretation of what is lapseing to the company. This is because if it does, so there is no need of the Cash Flow Statement, as the nitty-gritty are present in the Balance Sheet (Statement of Financial Position).Usually the increase in Inventories and Receivables would give an indication that the company is organism illiquid compared to last period. fetching the Dowlais Iron Company (mentioned in the Introduction) as an example, the company were making profits, but they were unable to do any investment. The reason being was that their assets are illiquid and are composed by high amount in inventories. This might to a fault be an alarming situation as it gives the signal of the company being unable to collect their debts. Other elements has their own story respectively. Lets move a step further in our discussion, comparing elements.Taking the investing activities as an instance, the sale or disposal of assets by itself may be infer as a hint of the company wanting to get rid of the old machines in order to buy a new one that is more productive in their expansion plan. However, if it is synchronized with the decrease in investment in subsidiaries, it may give a different story. There is a huge possibil ity that the company is closing down and try to permit go as much assets as possible. Previously, we have compare the positive cash flow from operating with the negative cash flow from investing (in previous point).Now, lets compare elements in the investing activities with the elements in the financing activities. Firstly, the issuance of shares would obviously bring the positive vibe to investors as it is often read as expansion of the business. Business seems to be growing and thus, there were investors elicit and bought the shares which in the statements would report an increase in number of shares. The twist in this comparison would be the decrease in amount payable or repayments to directors/shareholders is around the amount if shares issued.Without reading the complimentary notes, it can be imitation that the company is capitalising their debts, that is paying their debts through issuance of shares. This can be support by reading the complimentary notes. When this happens , it gives an extreme situation of the inability of the company to pay their debts, up to the extend they have to exchange it with the shares (sense of ownership to the company). The Cash Flow Statement should be analysed thoroughly, it gives lots of information. Real Life CaseAll these suppositious can be easily argued and rejected by certain parties, particularly those who does not want to have hassle to prepare another financial statement. This point will give the flavour of the real life situation, when the Cash Flow Statement was not prepared, by using the W. T. Grant Company back in the 1970s. From the surface, it has the similar picture of the Dowlais Iron Company making profit, good assets amount, but no cash. Having mentioned that, the Dowlais Iron Company took the trouble to make a comparison balance sheet, while the W.T. Grant Company runs as though there was no problem. By purely looking at the Net Income amount, the investors were keen to invest in W. T. Grant Company as it seems promising and the earnings look tempting. Little did the investors know, the company was not generating any cash, instead they are the net user of cash. This problem does not happen within a financial year, it started a decade before the pin of the company. There were decreasing trends of the companys liquidity, profitability and even turnover. However, all these problems were left ntouched and thus, the investors were not given any hint that the W. T. Grant Company was facing bankruptcy. The company was said to exhaust its liquid assets before using external markets for funds which later just grew bigger. These can be easily detected with the use of Cash Flow Statement. Apart from the negative cash flow from operating activities, the company and investors could be alarmed by the amount of payables that kept on increasing, and even the shares that were sold above the value of the company, simply because the market conception the company was doing fine.The upward trend of sales still does not manage to generate cash for the company, and this could be detected by the increase in the Receivables, which shows the inability to collect debt. All these problems can be detected age before the liquidation of the company and could be avoided, with the presence of Cash Flow Statement. Conclusion With Cash Flow Statement, these elements are laid down in such manner that it is easier for the users of financial statement to understand the story, compare to entirely reading the Balance Sheet (Statement of Financial Position) and the Profit and Loss Statement (Statement of Comprehensive Income).The investors are able to have the idea of financial stableness of the company, together with the management of the company and what the company can achieve in the future. With these information, which are not present in any of the other two financial statements, the investors are able to make a wiser decision in making investments. Thus, the Cash Flow Statement is not redundant and is demand for investment decision making. Reference Cash Flow from Investing Activities (n. d. ). In Investopedia. Retrieved March 23, 2013, from http//www. investopedia. om/terms/c/cashflowfinvestingactivities. asp Cash flow statement (n. d. ). In Wikipedia. Retrieved March 19, 2013, from http//en. wikipedia. org/wiki/Cash_flow_statement Chinweike, (2010, June 25). Uses and Benefits of Statement of Cash Flow. Retrieved http//www. accountantnextdoor. com/uses-and-benefits-of-statement-of-cash-flow/ FAO Corporate Document alluviation (n. d. ). Chapter 3 Cash Flow Accounting. Retrieved March 20, 2013, from http//www. fao. org/docrep/W4343E/w4343e04. htm Kestenbaum, D. , (2012, October 4). The Accountant who Changed the World.Retrieved March 28 2013, from http//www. npr. org/blogs/money/2012/10/04/162296423/the-accountant-who-changed-the-world King, Lembke, Smith,. (2001). Financial Accounting A Decision Making Approach (Second Edition). In The Cash Flow Statement and Decisions. John Wiley and Sons, Inc.. Retrieved from http//www. wiley. com/college/bcs/0471238236/king/ch13. pdf Largay, J. A. Stickney, C. P. , (1980, July/August). Cash Flows, Ratios Analysis, and the W. T. Grant Company Bankruptcy. Financial Analysts Journals. 51-54. Retrieved from http//www. jstor. org/discover/10. 2307/4478363? id=3738672uid=2129uid=2134uid=4579947027uid=2uid=70uid=3uid=4579947007uid=60sid=21102061346117 Peavler, R. , (n. d. ). Cash Flow Ratios- Calculate the Solvency, Liquidity, and Viability of your Firm Cash Flow Ratios that are Important for Cash FlowAnalysis. Retrieved March 20, 2013, from http//bizfinance. about. com/od/cashflowanalysis/tp/cash-flows-ratios. htm INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA KULIYYAH OF ECONOMICS AND MANAGEMENT SCIENCES ACC 4001 ACCOUNTING THEORY AND form _or_ system of government POSITION PAPER THE STATEMENT OF CASH FLOW IS NOT senseless AND NECESSARY FOR INVESTOR DECISION MAKING