Your accountant has presented you with an up-to-date set of financial statements, and among the statements are an income statement and a cash flow statement. One of the purposes of financial statements is to provide you, the owner or manager, with relevant information on which to base important business decisions.
But which statement you'll use will depend on the decision you need to make, because a cash flow statement provides you with a different set of information from the information presented in an income statement.
Cash flow vs. income statemment
In order to better understand which statement you should be using, it's important to understand what kind of information each statement provides:
- A cash flow statement sets out a business's cash flows from its operating activities, its financing activities, and its investment activities.
- An income statement provides users with a business's revenues and gains, as well as expenses and losses, over a specific period of time. These numbers are then used to calculate a business's income-related figures.
Purpose of the income statement
The income statement is designed to show how much profit your business made during the specific reporting period covered by the statement. Income statements come in two formats—a single step income statement and a multi step income statement—and the type of income statement format your business uses depends on factors such as your business structure and the kind of information you need for decision-making purposes.
- The single step income statement is most commonly used by sole proprietors and partnerships. It is a simplified statement that focuses on a business's net income, or bottom line, which is determined by adding up the business's revenue and gains, and subtracting from this total the business's expenses and losses to obtain a net income figure. While a single step income statement might also break down the different revenue and gains, and expenses and losses, the information provided is not particularly detailed.
- The multi step income statement is a more detailed income statement format and is used by entities with a more complicated business structure, such as corporations. This format provides users with a detailed breakdown of both revenues and gains, and expenses and losses, and the focus isn't solely on a business's net income. The multi step income statement also provides users with the business's gross profit (obtained by subtracting the cost of goods sold from net sales) and operating income (obtained by subtracting operating expenses from gross profit).
Purpose of the cash flow statement
Unlike an income statement, the cash flow statement's purpose is to show how much cash your business generates (also known as cash inflows) and how much cash it's spending (known as cash outflows).
There are two types of cash flow statements: a direct cash flow statement and an indirect cash flow statement. The main difference between the two types of statements lies in how cash flows from operating activities are calculated. Because the direct method is more challenging for businesses that use accrual accounting, most corporations tend to use the indirect method in their cash flow statements. With the indirect method, adjustments are made to convert numbers from accrual basis to cash basis.
Which statement should you use?
If the decision you're making has to do with the profitability of your business—for example, you're dealing with issues such as whether you're generating a profit or a loss—you'll want to turn to your business's income statement. But if the decision you need to make has to do with, for example, the amount of debt obligation your business can safely take on, you will find the cash flow statement more helpful.
The cash flow statement and income statement are just two critical tools in managing your business. To be sure you have the financial and operational data you need—in an accessible format—reach out to your accounting team or other professionals. You can also hire an online service provider to assist with creating management and compliance-related documents, such as annual reports, to give you greater peace of mind.
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FAQs
There is no one statement that offers better financial insights than the other. Both the cash flow statement and income statement provide a unique view into the finances of a business, and are necessary to the overall understanding of how the company is operating.
Which is more important, cash flow or income statement? ›
But if the decision you need to make has to do with, for example, the amount of debt obligation your business can safely take on, you will find the cash flow statement more helpful. The cash flow statement and income statement are just two critical tools in managing your business.
Which comes first cash flow or income statement? ›
The three core financial statements are 1) the income statement, 2) the balance sheet, and 3) the cash flow statement.
Why is cash flow the best statement? ›
Cash flow statements, on the other hand, provide a more straightforward report of the cash available. In other words, a company can appear profitable “on paper” but not have enough actual cash to replenish its inventory or pay its immediate operating expenses such as lease and utilities.
When would you use a cash flow statement? ›
A cash flow statement tracks the inflow and outflow of cash, providing insights into a company's financial health and operational efficiency. The CFS measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses.
Which financial statement is the most important? ›
Typically considered the most important of the financial statements, an income statement shows how much money a company made and spent over a specific period of time.
What is the correct order of financial statements? ›
They are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders' equity. Balance sheets show what a company owns and what it owes at a fixed point in time. Income statements show how much money a company made and spent over a period of time.
Which financial statement to do first? ›
Income statement: This is the first financial statement prepared. The income statement is prepared to look at a company's revenues and expenses over a certain period, such as a month, a quarter, or a year.
Which financial statements go first? ›
The income statement is often prepared before other financial statements because it provides a summary of a company's revenues and expenses over a specific period. This information can then be used to calculate net income, which is an essential metric for understanding a company's profitability.
What are the disadvantages of the cash flow statement? ›
As a cash flow statement is based on the cash basis of accounting, it ignores the basic accounting concept of accrual. Cash flow statements are not suitable for judging the profitability of a firm, as non-cash charges are ignored while calculating cash flows from operating activities.
Cash flow statement is the financial statement that presents the cash inflows and outflows of a business during a given period of time. It is equally as important as the income statement ad balance sheet for cash flow analysis but it is not useful for checking net worthiness of the company.
What is the difference between income and cash flow? ›
Net income is the profit a company has earned for a period, while cash flow from operating activities measures, in part, the cash going in and out during a company's day-to-day operations. Net income is the starting point in calculating cash flow from operating activities.
Do banks use cash flow statements? ›
Despite this some banks do so and include a cash flow statement in the framework of their individual closing of accounts and annual reports. The statement shows chan- ges in their assets and the financing sources for a certain period.
What four things a cash flow statement tells you? ›
They show you changes in assets, liabilities, and equity in the forms of cash outflows, cash inflows, and cash being held.
Does cash flow go on the income statement? ›
The cash flow statement is linked to the income statement by net profit or net burn, which is the first line item of the cash flow statement. The profit or loss on the income statement is then used to calculate cash flow from operations.
What is the sequence of the cash flow statement? ›
A typical cash flow statement comprises three sections: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities.
What is the first step in an accounting cycle? ›
1. Identify and analyze transactions. The first step in the accounting cycle is to identify and analyze all transactions made during the accounting period, including expenses, debt payments, sales revenue and cash received from customers.
Is cash flow on the balance sheet or income statement? ›
A balance sheet is a summary of the financial balances of a company, while a cash flow statement shows how the changes in the balance sheet accounts–and income on the income statement–affect a company's cash position.
