Question

What contrasts are there between what is shown in cash flow statements and the need for firms to borrow at high rates and firms' income statements?

Answer 1

There is very clear difference between cash flow statement and income statement. As we are aware that for knowing real position of cash and for knowing flow of cash during a period, a firm prepare cash flow statement whreas for knowing real net income or net loss during a period, a firm prepare income statement.

In other words we can say that cash flow statement includes only those items which either results into cash inflows or cash outflows. So cash flow statement includes all items of cash inflow or cash outflow whether these items are related to accounting period or not. Thus actual cash paid or actual cash received in a accounting year will be shown in cash flow statement whether such transaction is related to that accounting period or not.

So on the basis of above explanation it is quite clear that cash flow statement shows cash flow & position of cash in a specified period.

In income statement of a firm, all relevant income, expenses, losses and gains are reported. Thus only relevant items related to income, expenses, losses, gains are recorded in income statement of that particular year. Thus it is clear that income statement records those items also that does not affect position of cash.

So it is quite clear now that income statement and cash flow statement both are prepared for different purposes and includes different nature items.

Now let’s see the need for firms to borrow at high rates.

A firm may required some funds for specific purpose so that firm has to borrow such funds at high rates. Suppose due to shortage of funds a firm has to borrow these short funds from the market at high interest rates. Cash is the blood for the firm and a firm may have sufficient net income but can face problem of short cash position thus these short cash position will be fulfilled from market at high interest rates. Such cash requirement may be for operational expense, working capital requirements, for purchase of some fixed assets, for repayment of current liabilities etc. Thus such requirements lead a firm to borrow from market at high interest rates.