Final answer:
We convert earnings to cash flows to give investors a more reliable financial health metric, free from potential accounting manipulations, which reflects the true movement of cash necessary for transactions such as investments, debt servicing, and operational funding.
Step-by-step explanation:
We convert earnings to cash flows for several reasons. First, investors care about cash flows because they are a more reliable indicator of a company's ability to generate the funds needed to continue operating and to finance future growth. Earnings, while important, can sometimes be manipulated through various accounting practices, thus cash flows provide a clearer picture of a company's financial health.
Moreover, cash flows represent the actual movement of cash within a company, relevant for making investment decisions. Investments are, inherently, made with cash—not profits on an income statement—which means that understanding cash flows is crucial for early-stage investors and other stakeholders when assessing the value and viability of a company. Additionally, factors such as reinvesting profits, borrowing through banks or bonds, and selling stock are all transactions that directly impact cash flows.
Furthermore, cash flows are not confined to the historical costs encapsulated within book values. They reflect the current financial activities and are vital for evaluating a company's ability to meet its financial obligations and to fund its operations and growth by various means, including investments from early-stage investors, loans, or the issuance of equity.