The Importance of Cash Flows and Cash Flow Statements

Cash flow statements provide a wealth of information for the financial forensic examiner related to the actual cash operations of a company. Some companies may not include cash flow statements in their financial information, so the financial forensic examiner must prepare one in order to separate the accruals in the income statement from the actual cash transactions found in the cash flow statement. While it is easy to manipulate financial statements, the cash flow statement is more difficult (but not impossible) to manipulate. Tools and techniques applicable to the analysis of cash flows include a vertical analysis of the cash flow statement, comparing net income with cash realized from operations (CRO), and various cash flow ratios, including the operating cash flow ratio and the cash flow margin ratio. Comparing net income and CRO using a dual-axis chart allows the financial forensic examiner to compare the relationship between the two. The relationship between CRO and net income should be similar, and divergences from this pattern require further investigation to determine whether there are reasonable explanations for the divergence. If there are no reasonable explanations for the divergence, then the financial forensic examiner must consider the possibility of fraudulent transactions within the financial statements. Both the operating cash flow ratio and the cash flow margin ratio allow the financial forensic examiner to review a company's financial position by calculating whether the company can pay current debt from its cash received from operations or whether the company can generate cash from its sales.