Limitation of cash flow analysis

Answer 1

Analyzing a company's cash flow can give you a more detailed view of a company's financial health. A cash flow analysis gives the following advantages;

The cash flow statement is one of four basic statements publicly traded companies are required to regularly release for investors. This statement is broken down into three categories, each with its own subcategory. At the top, you will find net cash from operations. Below that is net cash from financing activities. Finally, at the bottom you will find net cash used for investing.

Net cash from operations represents income taken from the income statement and adjusted for depreciation, amortization, Accounts Payable and receivable, inventory and other, such as employee salaries. Most companies are in business to earn money from sales, not from their investments. Thus, if the company has more cash from operations than it does from investment activities, it tells you the company is earning most of its money doing business, not just earning interest on its investments.

The cash from financing section of the statement tells you how much money the company has been able to raise through bond issues and loan activities. The more money a company borrows, the more interest it will have to pay in the future. Moreover, paying back loans and bond payments robs the company of its ability to take advantage of future opportunities, so the less money the company raises through financing, the better.

The investing activities section of the cash flow statement tells you how much the company earned in interest on its investments as well as what types of investments it has made. If the company earns most of its interest from bank deposits and bonds, there is very little chance the company will benefit from future growth. However, if the company has invested its money into business capital, such as new plants and machinery, it may mean they will experience future growth, which can be reflected in higher future stock prices.