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 shows the exact amount of a company's cash inflows and outflows over a period of time. The income statement is the most common financial statement and shows a company's revenues and total expenses, including noncash accounting, such as depreciation over a period of time.
Is cash flow statement better than income statement? ›
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 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. These three financial statements are intricately linked to one another. Analyzing these three financial statements is one of the key steps when creating a financial model.
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.
How is a fund flow statement better than an income statement? ›
The excess or deficit in a company's current liabilities and assets can only be effectively viewed and scrutinized in the funds flow financial statement rather than the income statement or balance sheet.
Which financial statement is better? ›
The income statement will be the most important if you want to evaluate a business's performance or ascertain your tax liability. The income statement (Profit and loss account) measures and reports how much profit a business has generated over time. It is, therefore, an essential financial statement for many users.
Why is cash flow better than earnings? ›
Profit cannot precisely determine where your business stands, while cash flow can. It cannot be manipulated to show business growth when it's not the case. That's why owners and investors prefer to determine the health of a business based on the cash flow of an organization.
Which financial statement is the most important? ›
Types of Financial Statements: Income Statement. 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? ›
Financial statements are compiled in a specific order because information from one statement carries over to the next statement. The trial balance is the first step in the process, followed by the adjusted trial balance, the income statement, the balance sheet and the statement of owner's equity.
Which financial statement to do first? ›
An income statement is typically the first financial statement prepared. This statement lays the groundwork for both the balance sheet and the cash flow statement, showcasing the net income from revenues and expenses, which impacts assets, liabilities, and equity.
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.
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.
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 income statement better than cash flow statement? ›
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.
Which is more important balance sheet or income statement or cash flow? ›
However, many small business owners say the income statement is the most important as it shows the company's ability to be profitable – or how the business is performing overall. You use your balance sheet to find out your company's net worth, which can help you make key strategic decisions.
What is the difference between income and cash flow? ›
Namely, your net income represents the profitability of your business, while the cash flow will reveal how much cash you actually have on hand at a given time.
What is an advantage of a cash flow statement? ›
Advantages of a Cash Flow Statement
Cash Flow Statement helps the management to ascertain the liquidity and profitability position of businesses. Liquidity refers to one's ability to pay the obligation as soon as it becomes due.
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.
Is the cash flow statement the most important financial statement? ›
A possible candidate for most important financial statement is the statement of cash flows, because it focuses solely on changes in cash inflows and outflows.
Why might an analyst prefer to use free cash flow instead of earnings? ›
Some investors prefer to use FCF or FCF per share rather than earnings or earnings per share (EPS) as a measure of profitability because the latter metrics remove non-cash items from the income statement.
