“Cash is the lifeblood of any business” Essay Requirements
Cash is the lifeblood of any business, and without it, survival is very unlikely
This assessment point will evaluate your ability to demonstrate your knowledge of the literature and reading which relates to the learning objectives of the seminar. This response will be expected to be in the region of 800 – 900 words and will demonstrate
- understanding of the literature related to the subject matter
- the ability to critique established theories
- the ability to relate the theory and / or theoretical models to practice (likely to be your own experience).
Keep in mind
- check additional articles and use in your responce at least 7 significant peer-viewed articles (own research)
- use if possible 1-2 significant quotes to support your argumentation
- provide correct referencing and citation (Harvard)
TASK:
Thesis:
Cash is the lifeblood of any business, and without it survival is very unlikely.
In your paper:
- Do you agree or disagree?
- Explain what information a cash flow statement provides to supplement that provided by a statement of financial position and an income statement. Why is there still some controversy surrounding published cash flow statements?
- How important are such statements in terms of the financial reporting requirements within Europe? Make a statement about financial reporting requirements – Europe compared to Switzerland.
Your response should include:
- contribute original views
- show intelligent critique of theory or practice
- add an international or cultural aspect to the paper
- show originality in the application of theory
- clarify the theory being studied
- encourage the effective contribution of other members of the class.
Note: Please submit your initial response through the Turnitin submission.
Solution
Importance of Cash Flow Statements in Financial Reporting
Cash and cash equivalents are very important in the management the daily operating activities of a business. This is because most business transactions are carried out on cash basis. Businesses need cash to meet administrative and operating expenses, pay suppliers, creditors and employees and cater for any unforeseen events that might occur in the course of carrying out various tasks in the business. While a business can survive without ‘accounting profits’ it cannot survive without cash (Stittle & Wearing, 2008, p.70). Cash flows generally show whether the business is generating enough cash to meet its expenses and liabilities when they fall due. The management of cash flows is therefore very vital for business success and good performance. For this reason, public companies are required to include a statement of cash flows in their financial reports to provide information about the company’s cash inflows and outflows over the financial period being reported (Negakis, 2006, p. 635; Broome, 2004, p. 16). This information can be used to predict future cash flows and hence assists investors and creditors to make sound investment decisions. They also help firms to investigate the factors that cause variations in the relation between cash flows and credit risk within the firm hence putting them in a better position to make optimal economic decisions. Cash is the lifeblood of any business, and without it survival is very unlikely.
Cash flows statements analytically display the sources (cash inflows) and uses (cash outflows) of cash in a particular company for a given financial year (Negakis, 2006, p.635). According IAS 7, “information about cash flows of an entity is useful in providing users of financial statements with a basis to assess the ability of the entity to utilize those cash flows.” (Stittle & Wearing, 2008, p.69). The main purpose of cash flow statements is therefore to show how the business has generated cash and how the cash has been used for instance to make purchases or pay dividends to shareholders. Profit and loss accounts on the other hand only provide limited information about assets – only indicate depreciation of assets – and do not provide any information on how the company has increased its sources of finance. A major shortcoming of statements of income and financial position is the use historical costs, which can be very deceptive in periods of high inflation. Cash flow statements provide a better picture of the company’s performance hence facilitating more prudent decision-making. Apart from using historical costs, statements of income and financial position also allocate revenues and expenses to distinct times and are therefore prone to subjective assumptions, which facilitate the manipulation of financial reports. On the other end of the spectrum, Cash flows are objective and can therefore not be manipulated to provide misleading information to investors.
Over the years, there has been a lot of controversy over the use of casflow statements to determine the financial performance of public corporations. They latter are commonly perceived to contain limited “significant incremental information content over accrual information in discriminating between bankrupt and non-bankrupt firms.” (Sharma, 2001, p.3). Sharma however argues that there is a logical relationship between cash flow and bankruptcy. Bao & Romeo (2012 p. 27) have pointed out that another problem associated with cash flow statements is the classification of dividends and interest inflows and outflows. The two items are listed differently in the statement. Dividend income from investments is for instance classified under the operations section. This approach can cause distortions in the statement of cash flows when a company with significant investments has the ability manipulate or control the amount of dividends in the operations section. Other items such a capital leases also present challenges when it comes to classification. This is because there are two types of leases, which are treated differently on cash flow statements. Transactions involving operating leases are exclusively recorded under the operating activities while finance leases are dealt with both under the operating and financing section. Apart from that, different companies make different classification choices hence hindering effective comparison of financial performance across different firms using cash flow statements (Deloitte, 2011, p.12; Broome, 2004, p.16).
Cash flow statements provide information that can be used to predict future cash flows to help investors and creditors in making sound investment decisions. Consequently, the accounting standards used by European countries including the IFRS and GAAP require companies to include cash flow statements in their financial reports (Federal Finance Administration, 2008, p.8; Leuz, 2000 , p.182). Most countries in Europe use IFRS whose cash flow statements have standard headings but limited guidelines on the contents and the use of direct or indirect method. Switzerland on the other hand uses the Swiss GAAP FER that provides more guidance on the contents in the statements and examples of non-cash transactions (PricewaterhouseCoopers, 2007). Moreover, IFRS defines cash and cash equivalents with reference to the date of acquisition, while in the Swiss GAAP FER, they are defined with reference to the balance sheet date. Notwithstanding, cash flow statements are a very important aspect financial reporting. The significance of cashflow statements underscores the fact that cash is the lifeblood of any business and without it, survival is very unlikely.
References
Bao, D. & Romeo, G.C., 2012. Convergence to international financial reporting standards for the statement of cash flows: —“where got, where going”. American Journal of Business Research, 5(1), pp.23-37.
Broome, 0.W., 2004. Statement of cash flows: Time for change!. Financial Analysts Journal, 60(2), pp.16-22.
Deloitte, 2011. IFRS Survey 2011: Focus on Financial Reporting in Switzerland. [Online] Available at: http://www.iasplus.com/de/publications/schweizer-publikationen/ifrs-studie-2011-genauere-betrachtung-der-rechnungslegung-in-der-schweiz/at_download/file [Accessed 12 September 2013].
Federal Finance Administration, 2008. The New Accounting Model of the Swiss Confederation. OECD Journal on Budgeting, 8(1).
Leuz, C., 2000. The development of voluntary cash flow statements in Germany and the influence of international reporting standards. Schmalenbach Business Review, 52, pp.182 – 207.
Negakis, C.I., 2006. The cash flow statement: implications for the use of the direct or indirect method. Managerial Finance, 32(8), pp.634-44.
PricewaterhouseCoopers, 2007. IFRS US GAAP Swiss GAAP FER: Summary of similarities and differences. [Online] Available at: http://www.pwc.ch/user_content/editor/files/publ_ass/pwc_summary_similarities_and_diff_07_08_e.pdf [Accessed 12 September 2013].
Sharma, D.S., 2001. The Role of Cash Flow Information in Predicting Corporate Failure: The State of the Literature. Managerial Finance, 27(4), pp.3-28.
Stittle, J. & Wearing, B., 2008. Financial accounting. Los Angeles: SAGE Publications.
