Finances are an important part of any organization, big or small. When running an organization, it is vital to keep track of them to estimate the performance and the future growth. There are many ways to determine a company’s progress.
But income and cash flow statements are the two most used methods in finance. Investors also use these two metrics while making investment decisions. After reading this blog, you will get familiar with these two financial statements and how to use them.
What is a cash flow statement?
Running an organization is impossible without knowing the amount of business a company is making or spending. And the cash flow statement helps you with this exactly. With this, you can find the amount of cash coming in and out of the organization and from where.
It helps calculate the overall liquidity in the business, which helps in estimating the current and future state of cash flows. Three components come into the picture while noting the cash flow statement. They are operational, financial, and investing activities.
Below is the complete structure of a cash flow statement –
Operating
It includes all a company’s cash from its products and services. They incorporate receipts from sales of goods and services, interest & income tax payments, inventory transactions, interest payments, tax payments, wages to employees, payments for rent, etc. In gist, this compromises all the transactions done because of operational activities.
Investing
Investing activities cover resources and uses of cash from a company’s investments. This category includes activities like:
- The purchase or sales of assets
- Loans given to vendors or received from clients
- Payments pertaining to Mergers & Acquisitions (M&A)
Financing
It includes cash utilized in business financing: money that goes in and out between a company and its owners & creditors. It covers transactions involving dividends, stock repurchases payments, and the corporation’s principal debt repayment (loans).
How is cash flow calculated?
There are two ways of calculating cash flow statements – direct and indirect.
Direct
The direct method totals all cash payments and revenues, including cash paid to suppliers, cash received from consumers, and salary payments. This way of calculating cash flow is more suitable for companies that use accrual accounting.
Indirect
The indirect technique calculates cash flow by altering net income by adding or removing differences deriving from non-cash transactions.
What is an income statement?
An income statement’s purpose is to determine a business’s profitability. In short, it tells how much profit/losses a company makes for a given period of time.
Also referred to as a Profit & Loss (P&L) statement, statement of operations, and statement of revenues & expenses, an income statement depicts a company’s financial position by calculating the income statement for a particular month, quarter, or year.
How to find out net income with an income statement?
Calculating an income statement is a straightforward method. To find out, we add all the revenues from operations and subtract all costs. These operations include both operating and non-operating costs.
Operating activities include all the activities related to running a business, such as purchasing, manufacturing, selling, and distributing goods and services. On the other hand, non-operational activities refer to those that are related to the sales and purchase of investments and assets. They also include payment of dividends, takes, and interest & FX gains/losses.
An income statement gives us the net come. If it is positive, then the company is in profit. However, the negative value indicates the net loss.
Cash flow statement vs. income statement
Purpose
Cash flow monitors money that goes in and out of business. At the same time, the income statement determines how much profit or loss a company is in.
Format difference
We need both the income statement and the company’s balance sheet to make the cash flow statement format. In contrast, the income statement format requires various ledger accounts & records of a company.
Activities
We use two activities – operations and non-operation, in finding out the income statement. On the other hand, the trio of operational, financial, and investing activities helps determine the cash flow.
The Derived System
The income statement is generated on an accrual basis, which means that the income and costs of a certain period are regarded. The cash basis is used to construct the Cash Flow Statement – how much money goes back and forth in a business.
Depreciation
Depreciation is not reported in cash flow since it is a non-cash item. Still, it is recorded in the income statement.
What statement should you go for?
Both the financial statements are important determinants that serve a purpose in a company.
Suppose you want to measure how well the business is performing – what profits and losses are occurring. In that case, you should consider an income statement.
On the other, If you want to know anything about your business, such as how much debt your company may safely take on or how to create more cash, you should look at cash flow figures.
FAQs
How to calculate cash flow and income statement?
To calculate net income, sum all operations revenues and deduct operations. These costs include both running and non-operating expenses. You can calculate cash in two ways – direct and indirect.
However, a common method is to deduct your taxes from the amount of depreciation, working capital change, and operating income.
What are cash and non-cash items?
Any transaction involving a company giving or receiving cash is a cash item. Unlike cash items, non-cash items refer to some expenses & revenue without cash transactions.
Examples of cash items include salaries & wages, rent payments, and other payment services. Depreciation, stock-based compensation, and unrecognized profits or losses are examples of non-cash expenses.
How is the balance sheet different from cash flow and income statements?
At a given point in time, balance sheets reflect what a corporation has and what it owes. The balance sheet formula tells that the organization’s total assets are the sum of its equities and liabilities.
The Bottomline
Financial statements are crucial components of any business because they help understand a company’s performance and growth. The cash flow and income statements are the two financial statements we discussed in the blog.
Cash flow helps you understand the flow of money in your business, whereas an income statement gets you an idea about the profitability of your business.
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