Question

Undeniably, profitability is the ultimate goal of companies and readers of a company’s financial statements are very much interested in the reported profit figure. The profit figure is achieved by the preparation of the statement of profit or loss and the statement of financial position. If the foregoing is the

case, why then bother about the statement of cash flows?

Answer 1

The fundamental accounting concept based on which financial statements are prepared is accrual concept. In accrual concept of accounting expenses are recognised in financial statements when they are incurred and not when they are paid. Revenue is recognised based on when service is performed and not when cash is received for service performed. Hence accrual concept ignores receipts and payments of cash. The profit and loss account helps in understanding net profit or loss during the period. But is does not help in understanding movement of cash and cash equivalents during the period. A Statement of cash flows can help in understanding cash flow situation of an organisation and helps in overcoming the drawbacks of income statement.

For example: A firm having high profits can have lower cash flows during the year which can affect its cash position. The users of financial statements cannot understand the cash position of the firm from the income statement but a statement of cash flows can help in understanding movement of cash during the year and make informed decisions. It helps in identifying sources of cash flows and where it is being used in the firm.