Question

Which do you feel is more important, net income or net cash flow? Why?

What might a Cash Flow Statement tell you that an Income Statement would not?

The Cash Flow Statement has only been required in the United States since 1988. Why do you think it has risen in importance since then?

Answer 1

Both net income and net cash flow are equally important while analysing financial statements of an organisation. A firm should manage its net income while generating positive cash flow. Net cash flow is important from solvency point of view since organisation would need cash to pay its operating expenses and meet its financing requirements like repayment of loan and interest. Income statement helps in computation of operating profit or loss and net income or loss during the period. It helps in understanding earning per common share.

Income statement is prepared on accrual basis concept hence it would have income and expenses which do not have actual cash inflow or outflow for example: goods sold on credit basis, depreciation and amortization expenses, gain or loss on sale of fixed assets and investments, etc. Hence Income statement does not give an idea of cash flows generated during the year. To overcome this drawback cash flow statement is prepared since it helps users in understating how cash flow movements happen during the year. A highly profitable company may have poor cash flows if it does not manage its cash flows in a proper way. Hence a cash flow statement is important to various stakeholders for understanding cash flow movements during the year.

The importance of cash flow statement in recent years has increased due to many firms becoming bankrupt due to non availability of cash in their operations. Non availability of cash affects the solvency of the firm since it cannot pay its operating and financing requirements on time. Hence cash flow statement is made mandatory to be reported as part of financial statements so that end users and stakeholders get to understand the cash movements in the firm and take informed decisions regarding the operations of the firm.