ANALYTICAL APPLICATIONS
Although privately held and highly leveraged companies illustrate most vividly the advantages of the cash flow statement, the statement also has considerable utility in analyzing publicly owned and more conventionally capitalized firms.
One important application lies in determining where a company is in its life cycle, that is, whether it is “taking off,” growing rapidly, maturing, or declining. Different types of risk characterize these various stages of the life cycle. Therefore, knowing which stage a company is in can focus the analyst’s efforts on the key analytical factors. A second use of the cash flow statement is to assess a company’s financial flexibility. This term refers to a company’s capacity, in the event of a business downturn, to continue making expenditures that, over the long term, minimize its cost of capital and enhance its competitive position. Finally, the cash flow statement is the key statement to examine when analyzing a troubled company. When a company is verging on bankruptcy, its balance sheet may overstate its asset value, as a result of write-offs having lagged the deterioration in profitability of the company’s operations. On the other hand, the balance sheet may fail to reflect the full value of certain assets recorded at historical cost, which the company might sell to raise cash. The income statement is not especially relevant in the context of pending bankruptcy. For the moment, the company’s key objective is not to maintain an impeccable earnings record, but to survive. The cash flow statement provides the most useful information for answering the critical question: Will the company succeed in keeping its creditors at bay?
Source:
Fridson M., Alvarez F.. Financial Statement Analysis. John Wiley & Sons, Inc.,2002. — 413 p. 2002
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