Question

Distinguish between income statements and cash flow statements. Why do company need both?

Answer 1

Difference between the Income Statement and the Statement of Cash Flows

1) Meaning: The income statement is a part of financial statement which is used to show the revenues, gains, expenses and losses for a particular accounting period. The cash flow statement is a part of financial statement which is used to reflect the inflows and outflows of cash for a particular accounting period.

2) Objective: The objective of the income statement is to know the profitability and owner's equity. On other hand cash flow statement motive is to ascertain the liquidity and solvency of business.

3) Division: The income statement is divided into two activities. Conversely, the Statement of Cash Flows is divided into three activities

5) Depreciation: Depreciation is considered in the income statement, however not included in Statement of Cash Flows

Yes, a business can show a profit, but have a negative cash flow and vice versa. The statement of cash flow reflects how the company is dealing with its cash and where cash is being generated, however these do not reflect the entire financial condition of the company. Negative cash flow doesn’t necessarily mean company is not profitable and vice versa. Because cash flow can be positive however the profitability is negative, thus it is important that investors should analyze both - income statements and cash flow statements. Cash flow can be negative however still be profitable due to:

-- A pre-payment of an expense such as insurance would involve more cash-out instead of what was expensed.

-- Investment in assets such as new equipment which would involve substantial cash-out however the equipment can only be expensed in accounting using depreciation, which means writing off as an expense proportionally over its years of useful life

--A repayment of loan will have impact on company’s cash-out however only the interest component of the repayment will be deducted as an expense from the revenue to determine profits. Thus by this way the principal component of the loan repayment decreases the company's liability however does not affect the profit

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