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Cash Flow Learning Trail
Why Prepare and Examine Cash Flow Statements?
When we prepare and examine Cash Flow Statements we do it for one of two reasons:
- Because a business should always compare its actual cash flow with its predicted cash flow. This comparison will demonstrate if things have worked out as expected, or not. If they have not worked out as expected, then the reasons for this difference should be examined. This will help a business plan for the future more effectively, and may help prevent a shortage
of cash. We can only do this comparison if we have both sets of figures, actual and predicted.
- We can look at a cash flow forecast on its own (this is also known as the predicted cash flow). This is used to tell us if the business is likely to have enough money coming into the firm to pay all of its expenses. If the forecast cash flow tells us that it does not have enough money coming in, then the business must arrange to obtain the
required amount of money. This can be done internally or externally. Perhaps the most popular method of funding a shortage of cash is to borrow from a bank (external) and this borrowing can take the form of loan or an overdraft, but there are other methods of funding, each of which have an important part to play. We will examine these later in this section.
Very Important: A cash flow statement does not show the profitability of a company, only a Profit and Loss Account shows how much profit a business is making. We will see exactly why this is later.
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