Question

1. What is Share Holders Equity and how is reflected in the Accounting Equation?

2. How is Share Holders Equity generated in the firm and what does it represent?

3. What important data is provided by the Statement of Cash Flows?

4. Why would the investor be concerned with the statement of cash flows when they have the income statement provided?

Answer 1

Answer to Q1

Shareholders' equity represents the interest of a company's shareholders in the net assets of the company. It equals the excess of a company's total assets over its total liabilities.

This fundamental relationship is expressed in the form of accounting equation, which is as follows:

Assets = Liabilities + Shareholders' equity

Answer to Q2

Shareholders' equity represents the net value of a company, or the amount that would be returned to shareholders if all of a company's assets were liquidated and all its debts repaid. In short, shareholders' equity measures a company's net worth. It can be found on a company's balance sheet, and it's a common financial metric used by analysts to determine the financial health of a company.

We can calculate a company's shareholders' equity by subtracting its total liabilities from its total assets, which are listed on the company's balance sheet. The formula for calculating shareholder equity is:

Shareholders’ Equity=Total Assets − Total Liabilities

Shareholders' equity represents the amount of financing the company experiences through common and preferred shares. Shareholders' equity could also be calculated by subtracting the value of treasury shares from a company's share capital and retained earnings.

Answer to Q3

Cash Flow Statement importance is that it measures the cash inflows or cash outflows during the given period of time. Such details of the cash position of the company can not only help the company or the financial analyst to plan for the short term or long term but also in analyzing the optimum level of cash and working capital needed in the company.

There are three categories under which the cash sources and the uses of the cash are divided which include:

• Cash flow Statement from the operating activities is important as it focuses on cash flows from the main activities of the business like selling and buying of the merchandise, provision of the services, etc.
• Cash flows Statement from the investing activities is important because it provides details of purchase and sale of the capital assets of the company i.e. the assets having a useful life of more than one year as per the balance sheet of the company.
• Cash flows Statement from the financing activities is important as it considers the stock purchase or sale by the company and any other proceeds or payments with respect to the debt financing. Thus they are the section in the cash flow of the company which reflects the net flows of cash of the company which is used for the funding.

Answer to Q4

The statement of cash flows tells you how much cash went into and out of a company during a specific time frame such as a quarter or a year. You may wonder why there's a need for such a statement because it sounds very similar to the income statement, which shows how much revenue came in and how many expenses went out.

The difference lies in a complex concept called accrual accounting. Accrual accounting requires companies to record revenues and expenses when transactions occur, not when cash is exchanged. While that explanation seems simple enough, it's a big mess in practice, and the statement of cash flows helps investors sort it out.

The statement of cash flows is very important to investors because it shows how much actual cash a company has generated. The income statement, on the other hand, often includes non cash revenues or expenses, which the statement of cash flows excludes.

One of the most important traits you should seek in a potential investment is the firm's ability to generate cash. Many companies have shown profits on the income statement but stumbled later because of insufficient cash flows. A good look at the statement of cash flows for those companies may have warned investors that rocky times were ahead.