Question

Your friend, Diana Warner, recently completed the second year of her business and just received annual financial statements from her accountant. Warner finds the income statement and balance sheet informative but does not understand the statement of cash flows. She says the first section is especially confusing because it contains a lot of additions and subtractions that do not make sense to her. Warner adds, "The income statement tells me the business is more profitable than last year and that's important. If I want to know how cash changes, I can look at comparative balance sheets."

1. Write a half page memorandum to Diana explaining the purpose of the statement of cash flows and post it to our discussion board.
2. After you have posted, you will have access to the threads created by your classmates. Write a response to one classmate. Include in your response (in your opinion) the one most important purpose of the statement of cash flows that your classmate named, and why you feel it is highly important.

Answer 1

The Income statement is prepared on principal of “Accrual Accounting” which means revenues and expenses are recorded when these occurred, regardless of when cash is received or paid.

Hence, the traditional Income statement and Balance Sheets do not give information on inflows and outflows of cash.

A business may be highly profitable as per Income statement ,still it may not have enough cash flow to meet its obligations. Its income may be locked up as accounts receivable.

Cash Flow Statement is complementary to Income Statement and Balance Sheet tounderstand Cash flow in various activities like Operating, Investing and Financing activities.

Cash Flow statement show where cash are generated(Operations, Disposalof Plant and Equipments, Financing activities like issue of shares or through debts) and where cash is spent over a period of time)

Cash flow statement is based on cash basis accounting which is complementary to accrualbasis accounting for Income Statement and Balance sheet