Cash flow analysis is a helpful tool in evaluating the effectiveness with which the management has controlled the working capital. If the Chas flows from operating activities are greater than or substantially equal to the profit for the period, it may be an indication that the working capital has been managed effectively and efficiently. If the cash flows are not equal it means that working capital management needs improvement.
For example, net profit for the period is $10 million and cash flows from operating activities are $2 million. This is an indication of poor management of working capital. The reason of shortfall may be the tying up in inventories and collection efforts of debts have been deteriorated. If same trend continues unchecked the future profits will be adversely decline. Also if the cash flows from operating activities are not adequate and the shareholders are not contributing with more funds, the entity will have to depend on the borrowings to meet its current obligations. In such a situation it is unlikely that the entity can continue to be solvent in the long run.
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