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
A cash flow statement is a regular financial statement telling you how much cash you have on hand for a specific period. While income statements are excellent for showing you how much money you've spent and earned, they don't necessarily tell you how much cash you have on hand for a specific period of time.
Which is more important income statement or cash flow 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 statement is more useful the income statement or the statement of cash flows? ›
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.
Why is statement of cash flows more useful than statement of comprehensive income? ›
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.
Why is cash flow more important than income? ›
In this example, cash flow is more important because it keeps the business running while still maintaining a profit. Alternately, a business may see increased revenue and cash flow, but there is a substantial amount of debt, so the business does not make a profit.
Which financial statement is most useful? ›
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.
Why is cash flow statement the best? ›
A cash flow statement is a valuable measure of strength, profitability, and the long-term future outlook of a company. The CFS can help determine whether a company has enough liquidity or cash to pay its expenses.
Why is the income statement the most important? ›
Importance of an income statement
An income statement helps business owners decide whether they can generate profit by increasing revenues, by decreasing costs, or both. It also shows the effectiveness of the strategies that the business set at the beginning of a financial period.
Why is the statement of cash flows not useful? ›
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.
Which financial statement is most important to creditors? ›
Statement of Cash Flows
The cash flow statement focuses solely on the inflow and outflow of cash, which is a good barometer for lenders and investors to use for evaluating how your business is operating.
However, some disadvantages are that a CFS (1) fails to present net income or fully assess liquidity; (2) is not a substitute for an income statement or funds flow statement; and (3) does not assess future cash flows or allow for inter-industry comparisons.
What are the advantages of cash flow statement? ›
The Cash Flow Statement provides a comprehensive view of a company's financial performance. It is important for assessing a company's liquidity, financial health, and its ability to meet its short-term and long-term obligations.
Why is a cash flow statement important if you already have an income statement? ›
So, even if you see income reported on your income statement, you may not have the cash from that income on hand. The cash flow statement makes adjustments to the information recorded on your income statement, so you see your net cash flow—the precise amount of cash you have on hand for that time period.
Which is more important, net income or cash flow? ›
Although many investors gravitate toward net income, operating cash flow is often seen as a better metric of a company's financial health for two main reasons. First, cash flow is harder to manipulate under GAAP than net income (although it can be done to a certain degree).
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.
What is more important cash flow or balance sheet? ›
There is no need to compare whether a cash flow statement or balance sheet is more important. They both reveal unique insights and information about a business's finances and can be used to create informed future decisions and forecasts.
Which is more important net income or operating cash flow? ›
Many investors and analysts prefer using operating cash flow as an indicator of a company's health. Net income is important to investors and analysts but does not necessarily provide a complete picture of a company's development.
