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The statement of cash flows has been a required part of annual financial statements for more than two years. While there has been considerable support for this statement since its proposal in 1986, little has been written or developed on the effective use or analysis of it. This article provides suggested ratios that can be used by financial statement users to analyze and evaluate corporate cash flows.
Analysts have traditionally evaluated financial statements using financial ratios. Any text on coporate reporting or any analyst's report contains ratios comparing information from the balance sheet and income statement. These ratios are used for comparison with prior years, other companies or industry norms. To date, neither text writers nor analysts have developed ratios for effective evaluation of the statement of cash flows. Such ratios, used in conjunction with traditional balance sheet and income statement ratios, should lead to a better understanding of the financial strengths and weaknesses of the underlying entity.
PURPOSE OF THE STATEMENT OF CASH FLOWS
The Financial Accounting Standards Board, which issued Statement no. 95, Statement of Cash Flows, in November 1987, describes the primary purpose of the cash flow statement as providing relevant information about an enterprise's cash receipts and payments during a particular period. The FASB suggests this statement be used by investors, creditors and others to assess
* An enterprise's ability to generate future positive net cash flows.
* An enterprise's ability to meet its obligations and pay dividends, and its needs for external financing.
* The reasons for differences between net income and associated cash receipts and payments.
* The effects on an enterprise's financial position of both its cash and noncash investing and financing transactions during the period.
If cash flow information is useful but unused, the logical conclusion is the business world is not analyzing available data properly. The solution is to develop tools that allow comparison of companies on a year-to-year basis and across companies. Although this article limits its approach for measuring performance to cash flow ratios, use of trend analysis and an evaluation of traditional accrual-based ratios are equally important in the analysis of financial statements.
CONTENTS OF CASH FLOWS
The statement of cash flows requires cash flow disclosure by the functional areas of operating, investing...