Why the Cash Flow Statement Matters

  • Peter Lynch

The cash flow statement doesn’t always get the attention it deserves. If you think about valuation metrics most frequently cited in the press or analyst reports, most pull from the income statement: price-earnings ratio (P/E ratio), earnings per share (EPS), multiples of EBITDA, multiples of revenue, etc. This might encourage anyone new to valuation or financial modeling to spend a disproportionate amount of time examining the income statement.

For this reason I wanted to provide the passage that follows. It is taken from a PwC report emphasizing the importance of the cash flow statement:

The statement of cash flows is regarded by many users of the financial statements in a number of industries as the most important financial statement. When combined with other financial information, the statement of cash flows can be a useful tool to analyze key relationships in the financial statements, evaluate past performance, and predict future performance. Further, because the income statement uses the accrual method, the statement of cash flows is needed to show cash generated and spent.

The statement of cash flows can reveal circumstances in which earnings growth does not correlate with operating cash flow growth. This may alert users to the need to look closely at the drivers of earnings or may be an indicator of other lifecycle considerations for emerging or declining businesses. The statement also facilitates a user’s assessment of a company’s ability to generate cash from core business activities, which is often a key variable when valuing a business and assessing its ability to repay debt, make capital expenditures, and pay dividends.

Credit rating agencies, investors, and analysts utilize cash flow information when developing valuation models. The transparency of historical cash flow information, including cash inflows and outflows from operating activities, can promote a better understanding of a company’s relative performance and enhance the predictive value of its cash flow results.

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