Free Accounting Dissertations - Cash Flow From Operations Is The Most Important Thing That Investors Look
Cash flow from operations is the most important thing that investors look for valuing a company. It shows what is the maximum level of cash that can be withdrawn from the business and hence defines the upper limit of valuation.
But a company also needs investment to replace and upgrade machinery and technology. Investors can look at the net cash flow after investing to see whether overall activities yield a positive cash flow or not.
Lastly by looking at cash flow under financing, investors can see how a company’s activities have been funded. Cash flow from financing activities clearly shows whether company has utilised external sources of funding to finance its activities in that year or it has used internal cash generation to repay loans. It is also useful in predicting claims on future cash flows by providers of capital.
By clearing demarcating three categories, IAS 7 format makes it much easier for investors to analyse the financial statements of the company. Under FRS 1, though there are eight categories but an investor would have to add them to get a clear picture.
Reconciliation to net debt
FRS 1 requires companies to have a cash flow statement reconciliation showing movement in cash flows to the movement in net debt. This is shown as a note after the main cash flow statement. IAS 7 doesn’t have any provisions for such thing.
This is a helpful feature for investors as they can see where cash is coming from to reduce debt or from what external sources of cash are being used in increasing debt levels. Investors look at net debt levels to see signs of financial distress. Presenting a concise statement showing movement in net debt is a useful tool in investors hand for analysing companies.
Management of liquid resources
FRS 1 requires cash flow statements to contain a separate heading on management of liquid resources. Cash flows relating to short term deposits and other similar cash equivalents are now reported under ‘management of liquid resources’. Now investors can make a clear distinction between cash flows arising from liquid resources from those of other investing activities. This segregation reflects better the way a company manages its cash flows.
CONCLUSION
FRS 1 and IAS 7 both describe the content and format of cash flows. IAS 7 and FRS 1 standards differ in the definition of cash and translation methods of foreign exchange. This would result in different cash flow comparisons and different financial ratios. IAS 7 format is better suited for financial analysis. On the other hand FRS 1 has advantages in terms of more conservative in definition of cash and contains more categories and layers of information. FRS 1 also includes additional notes on net reconciliation.
BIBLIOGRAPHY AND REFERENCES
Accounting Standards, 2004/2005, Extant at 30 April 2004, CCH.
International Financial Reporting Standards (IFRSs) 2004, International Accounting Standards Committee Foundation.
Dissertations - Free Accounting Dissertations
