Embracing Cash Flow Ratios for Predicting Financial Future - Capstone Project Example

Financial ratios have failed to accurately predict the financial position of companies. Despite their widespread use in the financial world, the constant occurrence of business bankruptcies seriously highlights the inherent weaknesses of these ratios. Beyond any doubt, due to these shortcomings in these ratios, predicting successful or failed businesses have become a necessity; this necessity can be properly filled up if the use of cash flow ratios is adopted as these ratios do not take into account the subjective measures and depreciation.

The fundamental difference offered by the cash flow ratios emanates from their cash basis procedure rather than an accrual basis.Cash flows have become a significant part of the performance and position evaluation of a company’s yearly performance. And, in this regard, Rose et al., (2007) contend that the cash flow information facilitates the users of financial statements in a way to receive the related financial information relating to the source and use of particularly the entire financial resources over a particular time period.

And that financial information is classified into the different segments of cash flow ratios statement such as operating, investing, and financial activities (Macve, 1997). However, cash flow ratios have not been in use as the other financial ratios such as liquidity, investors, and so on. Thereby, technical and investment fund managers and analysts have been using these measures to determine and evaluate the performance and position of companies. Despite their widespread use for the purpose of evaluation, these financial ratios have been unable to timely identify the possible presence of shortcomings in the strategic and operational policies of the companies.

In this regard, Albrecht (2003) argues that these forms of ratios are inherently affected by the fundamental weaknesses of ‘accrual-based accounting.’  Various financial statement stakeholders hardly rely on the projections and representations of the statement of financial position and the statement of financial position. First, in order to identify a company in real possession of the amount of cash in a particular period of time, many investors and other stakeholders try to establish this fact by analyzing the amount of net income to represent this fact.