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 Statement
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.