Question

Please discuss on the topic below; "How do investors, creditors, and others typically use the information in the statement of cash flows?"

Answer 1

Cash flow information is very useful information and in fact the most useful statement for a firm. This is because accrual accounting does not project the actual cash flow in the profit and loss statement. This statement is very useful from multiple user point of view

1) Investors

From an investor point of view, statement of cash flows is the primary statement used especially for value investing. The free cash flows are estimated and then discounted at the cost of capital (WACC) to arrive at the value of the firm. The value of the firm is then compared with the market price being traded to assess whether the stock is underpriced or overpriced.

2) Creditors

Creditors look at cash flow statement keenly as they get paid their liabilities from the cash generated by the firm. The cash flow coverage ratio defined as the ratio of EBITDA(Earnings before interest tax, depreciation and amortization) to the Interest obligation is a very important parameter to gauge the repayment capacity of the firm.

3) Others point of view

Cash flow is an essential statement for other stakeholders of the firm like the suppliers, customers and employees and they all get paid out of the cash flows from the firm. The customers can get interest free credit if the cash flow is robust enough.