How Investors and Lenders Use the Statement of Cash Flows - dummies

How Investors and Lenders Use the Statement of Cash Flows

By Kenneth Boyd, Lita Epstein, Mark P. Holtzman, Frimette Kass-Shraibman, Maire Loughran, Vijay S. Sampath, John A. Tracy, Tage C. Tracy, Jill Gilbert Welytok

Users of the statement of cash flows are primarily interested in whether the company has positive cash flows from operations. As a general rule, a company should be covering its costs by the cash it brings in from the day-to-day running of the business, rather than from borrowed funds.

A potential investor or creditor wants to see that cash the company brings in through operations exceeds any cash brought in by selling assets or borrowing money. This is because selling assets or borrowing money can never be construed as a continuing event, such as bringing in cash from selling goods or services.

A company may issue stock or bonds in order to expand its operations. On a nonrecurring basis, that situation can be okay because successful expansion is a good thing for investors and creditors. Successful expansion leads to more sales and higher overall profits.

However, unless cash from operations exceeds cash from other sources with some consistency, a company will be paying back debt with either more debt or equity being issued, which is decidedly not a good thing.

Here’s how investors and lenders use the statement of cash flows:

  • Investor: An investor wants to make sure the corporation has enough cash flow to pay an adequate return on investment. In other words, can the investor anticipate getting a cash dividend each year?

    Also important is using the statement of cash flows to evaluate how well the company is managing its cash because investors may eventually sell their shares of stock. If the company mismanages its cash to such a point that it goes out of business, there won’t be any buyers for the company’s stock — the stock may be worthless.

  • Creditor: The creditor also has a vested interest in making sure the company has sound cash management. After all, in addition to the interest expense the debtor pays for the use of the loan, the creditor wants to make sure it also gets paid back the principal portion of the loan. It’s never a good sign if a business is paying back debt by assuming more debt or issuing more equity.