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Analyzing Cash Flow

As noted previously, there are various reasons that you would want to determine how a company uses its cash assets. The choice to use cash to acquire an asset, meet a liability, or retire a debt is a process of investment and disinvestment, and there are always choices, some smart and some maladroit, that a manager can make. It's important to keep track of how well a company's management is making these choices.

Furthermore, the accrual method of accounting, for all its usefulness in matching revenues with expenses, tends to obscure how cash flows through a firm. One of the purposes of cash flow analysis is to highlight differences between, say, net income and the actual acquisition of cash. For example, accounts receivable is one component of net income, but it will not show up as cash until the check makes it to the bank. A company may have a healthy net income, but if its customers do not pay it on a timely basis it might have difficulty meeting its obligations. Cash flow analysis can illuminate problems, even impending problems, such as this.


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