Which financial statement is essential for understanding a firm's liquidity?

The cash flow statement is essential for understanding a firm's liquidity because it provides detailed insights into how cash flows in and out of the company over a specific period. This statement categorizes cash activities into operating, investing, and financing activities, allowing stakeholders to see how cash is generated and used.

Liquidity refers to a company's ability to meet its short-term obligations and fund its day-to-day operations, and the cash flow statement illustrates whether a firm has sufficient liquid assets to cover these needs. By analyzing the cash flow, investors and creditors can assess the company’s financial health and operational efficiency in managing cash, thereby understanding its liquidity position.

Other financial statements, such as the income statement and balance sheet, offer valuable information about profitability and overall financial standing, but they do not provide a complete picture of cash flow or immediate liquidity needs as clearly as the cash flow statement does. The statement of changes in equity focuses on changes in equity accounts and does not directly address liquidity either. Therefore, the cash flow statement is the most relevant for assessing a firm's liquidity.