Importance Of Cash Flow Accounting
Cash flow is the movement of money into or out of a business, project, or financial product from operating, investing, and financing activities. It is usually measured during a specified, finite period of time, or accounting period. The measurement of cash flow can be used for calculating other parameters that give information on a company's value, liquidity or solvency, and situation. Without positive cash flow, a company cannot meet its financial obligations (Figure 1).
Management is interested in the company's cash inflows and cash outflows because these determine the availability of cash necessary to pay its financial obligations. In addition, management uses cash flow for the following:
- To determine problems with a company's liquidity
- To determine a project's rate of return or value
- To determine the timeliness of cash flows into and out of projects, which are used as inputs in financial models such as internal rate of return and net present value
Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash even when it is profitable. Cash flow is often used as an alternative measure of a company's profitability when it is believed that accrual accounting concepts do not represent economic realities.
For example, a company may be profitable but generate little operational cash (as may be the case for a company that barters its products rather than selling for cash or when its accounts receivable turnover is long). In such cases if needed, the company may derive additional operating cash by issuing shares, raising additional debt finance, or selling its assets. In addition, cash flow can be used to evaluate the "quality" of income generated by accrual accounting. When net income is composed of large non-cash items, it is considered low quality.