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Homework answers / question archive / Discuss three things one can learn from evaluating the cash flow statements of an entity
Discuss three things one can learn from evaluating the cash flow statements of an entity. Explain why each of these is important for an analyst to understand in terms of the overall economic characteristics of a firm’s industry. Do not discuss items already addressed by your peers. In replies to peers, discuss whether you agree or disagree with the explanation provided by peers, and support your ideas by citing topic materials.
The statement of cash flows provides information to assess the financial health of an entity. An entity with a healthy income statement is not necessarily financially healthy nor is an entity with healthy cash flows. Discuss other factors that must be considered when assessing the financial health of an entity and provide examples that illustrate each of the scenarios listed above. Use examples not already provided by your peers. In replying to peers, discuss additional factors that must be considered when evaluating the financial health of the entities discussed in the examples posted.
The first thing an analyst can learn from evaluating the cash flow statements is the age and maturity of an entity. Entities that are in the start-up phase will have more negative cash flows from operations and investing activities compared to mature entities (Whalen, Baginski, & Bradshaw, 2018). This identification of maturity helps analysts to compare how other entities start-up or mature entities are performing. The second thing that helps analysts while evaluating cash flow statements is how non-cash components affect the operating cash flows. The non-cash components are items such as noncurrent assets that may cause the operating cash flow to be greater than the entity’s net income (Whalen et al., 2018). Understanding how these components affect operating cash flows allows analysts to understand how firms use non-cash components when forming cash flows. The final thing that is important for analysts to learn from cash flow evaluations is how to discern data from cash flow statements. Analysts use the data from cash flow statements to discern if managers are making aggressive decisions towards the non-cash components on balance sheets (Whalen et al., 2018). By identifying and studying this data, analysts can begin to study if the firm is actually growing or if its managers are aggressively reporting non-cash components on the cash flow statements.
Other factors that analysts should consider when assessing the financial health of an entity should include the characteristics of the industry and the growth rate of the firm (Whalen, Baginski, & Bradshaw, 2018). These factors help analysts to determine if an entity has robust financial health. Firms that have healthy income statements but be financially unhealthy when a firm is making enough revenue but takes on too much debt. This action of taking too much debt is an unhealthy situation because if the firm loses its revenue, it will struggle to pay those acquired debts. A firm might be financially healthy but have an unhealthy cash flow. An example of this is when a firm is in the introductory phase. When the firm is in the introductory phase, its operating and investing cash flows will be negative while it is still increasing its operating activities.
