Cash Flow or Income Statement: Which One Should You Use?

Cash flow and income statements are two financial statements that help businesses track their financial performance. While both statements provide valuable insights into a business’s financial health, they serve different purposes. In this article, we’ll take a closer look at cash flow and income statement, and help you decide which one you should use for your business.

Table of Contents

Understanding Cash Flow Statement
Understanding Income Statement
Cash Flow Statement vs. Income Statement
When to Use Cash Flow Statement?
When to Use Income Statement?
Frequently Asked Questions
Conclusion

Understanding Cash Flow Statement:

A cash flow statement is a financial record that exemplifies the progress of money into and out of a company during a required time frame. It helps businesses track their cash inflows and outflows from operations, investments, and financing activities.

A cash flow statement is divided into three portions: operating activities, investing activities, and financing activities.

The operating activities section shows the cash flows generated by the business’s day-to-day operations, such as sales and expenses.
The investing activities section shows the cash flows generated from buying and selling assets, such as property, plant, and equipment.
The financing activities section shows the cash flows generated from borrowing or repaying loans, issuing or buying back stocks, and paying dividends.

Understanding Income Statement:

An income statement, also known as a profit and loss statement, is a financial statement that shows a business’s revenue, expenses, and net income over a period of time. It helps businesses track their profitability and understand their revenue and expense trends.

An income statement is divided into three sections: revenue, cost of goods sold, and expenses.

The revenue section shows the income generated from the business’s primary operations, such as sales.
The cost of goods sold section shows the direct costs associated with producing the products or services sold.
The expenses section shows the indirect costs associated with running the business, such as rent, utilities, salaries, and marketing expenses.

Cash Flow Statement vs. Income Statement:

While both cash flow statement and income statement are important financial statements, they serve different purposes. A cash flow statement shows the actual cash inflows and outflows of a business, whereas an income statement shows the revenue, expenses, and net income of a business.

The main contrast between the cash flow statement and the income statement is that the income statement follows accrual accounting principles, while the cash flow statement uses cash accounting. Accrual accounting recognizes revenue and expenses when they are earned or incurred, regardless of whether the cash is received or paid at the same time. Cash accounting, on the other hand, records revenue and expenses when the actual cash is received or paid.

When to Use Cash Flow Statement?

You should use a cash flow statement when you want to:

Understand your business’s cash inflows and outflows.
Monitor your business’s liquidity and cash position.
Identify your business’s operating, investing, and financing activities.
Evaluate your business’s ability to generate cash.
When to Use Income Statement?

You should use an income statement when you want to:

Understand your business’s revenue and expenses.
Track your business’s profitability and performance.
Identify your business’s revenue and expense trends.
Evaluate your business’s ability to generate profits.

Both cash flow statement and income statement are important financial statements that serve different purposes. A cash flow statement helps businesses track their cash inflows and outflows, while an income statement helps businesses track their revenue, expenses, and net income. Depending on your business’s needs, you may choose to use one or both statements to track your financial performance. By understanding the differences between the two statements, you can make informed decisions about which statement to use for your business.

Frequently Asked Questions:

Question: Can a business have a positive net income but negative cash flow?

Answer: Yes, it is possible for a business to have a positive net income but negative cash flow. Net income is calculated by subtracting total expenses from total revenue, while cash flow is calculated by subtracting total cash outflows from total cash inflows.

A positive net income indicates that the business has earned more revenue than it has spent on expenses during a given period. However, a negative cash flow means that the business has more cash leaving the company than it has coming in.

There are several reasons why a business may have a positive net income but negative cash flow. For example, a business may have made a large sale, which increases its revenue and net income, but the customer has not yet paid for the sale. This means that the business has a positive net income but negative cash flow because it has not yet received the cash from the sale.

Another reason why a business may have negative cash flow despite a positive net income is if the business is investing heavily in its operations, such as by purchasing new equipment or expanding its facilities. These investments require a significant amount of cash outflow, which can temporarily result in negative cash flow even if the business is generating a positive net income.

Question: How can a business improve its cash flow?

Answer: There are several ways a business can improve its cash flow, such as:

Improving collections: Collecting payments from customers in a timely manner can help improve cash flow.
Reducing inventory: Reducing the amount of inventory can free up cash that can be used for other purposes.
Negotiating better terms with suppliers: Negotiating longer payment terms with suppliers can help improve cash flow.
Controlling expenses: Controlling expenses can help improve cash flow by reducing the amount of cash going out of the business.
Increasing sales: Increasing sales can help improve cash flow by generating more cash inflows.

Question: Can a business use both cash flow statement and income statement?

Answer: Yes, a business can use both cash flow statement and income statement. In fact, using both statements can provide a more complete picture of a business’s financial performance. While the income statement shows a business’s profitability, the cash flow statement shows the actual cash inflows and outflows of the business.