Cash flow vs income statement – UCL Coursework
What is accounting income?
After paying off all outstanding debts from earned sales revenue, a company’s accounting income is its remaining profit. The net income that businesses report on their income statement is essentially what is meant by “accounting income.” The accounting income is the final line item on an income statement that businesses and organizations prepare after deducting direct and indirect expenses. Additionally, sales revenues in cash and accounts receivable can be included in a company’s accounting income.
What is cash flow?
The movements of money into and out of businesses and organizations are referred to as cash flows. For instance, a company’s cash flow may consist of funds generated by its core business operations, investments and asset purchases, as well as any profits or returns on investments. These segments of a business’ cash flow show the activities that take place to generate cash and spend it to fund and invest in expansion and development.
Cash flow versus accounting income
Both cash flow and accounting income are crucial components of a company’s financial statements. For businesses to develop strategies for overcoming financial obstacles, plan for future growth, and monitor their financial well-being and profitability, cash flow and income statements are both essential. Despite these similarities, there are a number of critical differences that set cash flow and accounting income apart from one another.
Accounting methods
The accounting method used to track each financial metric on the cash flow and income statements is a significant distinction between cash flow and accounting income. Accountants track incoming and outgoing cash using either the direct or indirect cash flow accounting method on a cash flow statement.
The beginning and ending balances of a company’s cash that can be quickly liquidated are determined by adding up all of its cash payments and receipts using the direct method. All cash flow activities are taken into account by the direct method, and these values are reflected as increases or decreases in the cash accounts. The indirect method adds back any non-operating processes after deducting interest and taxes from the net or accounting income from the income statement.
The accrual method of accounting or the cash basis of accounting can be used to track revenues and expenses in an income statement. The cash-basis method limits the number of transactions that accountants record to those for which businesses receive payments as opposed to all sales transactions. Similarly, when using the cash-basis method, accountants only record expenses that have already been paid. In accrual accounting, the income statement, which represents a company’s present and future receipts and payments, is made up of all revenues and expenses.
Financial reporting
The cash flow statement, which accounts for all operational and non-operational activities that move money into and out of a business, is how businesses report their cash flow. Cash, cash equivalents, investments, and financing activities that generate cash for a company to invest and pay earned shares to stakeholders are reported in the cash flow statement.
Contrarily, accounting income records a company’s net profit after determining its revenues and subtracting operational and non-operating costs. The gross income from a company’s sales revenue is used to calculate the accounting or net income on the income statement. Unlike cash flow, accounting income can reflect both current and future income since accounts receivables aren’t yet fully paid. Accounting income can include both cash revenues and revenues from accounts receivable.
Planning implications
Cash flow is mainly used as a tool for investment planning and for determining how effectively businesses produce and use cash. When deciding whether to make an investment or to raise money for new business ventures, a company’s shareholders, investors, and lenders frequently consult the cash flow statement to assess the company’s financial position.
Furthermore, a company’s cash flow is crucial for determining how effectively it reinvests the money it makes in operations that foster growth and profitability. When investors and venture capitalists assess a company’s capacity for long-term profit generation, this kind of information is essential.
The income statement is more helpful for planning sales strategies, marketing activities, cost reduction integration, and other activities that directly affect business operations, even though accounting income can also provide insight into profitability. The income statement assists companies in forecasting sales, planning for new business initiatives that will increase revenue, and launching marketing campaigns that will boost the sales of goods and services.
Calculations
When businesses and organizations record these metrics, cash flow is calculated differently from accounting income. Typically, a business totals all cash from operations, investment income, and financing activities, and deducts any cash payments for related parties. The cash flow statement determines two cash flow metrics: payments to shareholders and dividend payments.
Contrarily, businesses total all sales revenue to determine the gross income on the income statement before deducting expenses. Depending on the accounting method a business employs, accounting or net income is produced by subtracting direct and indirect costs from gross income.
Profit and loss versus liquidity
In essence, cash flow can provide companies with information about the availability of cash and cash equivalents for shareholders and investors. This means that a company’s available liquid assets—or the assets that can be quickly converted into cash—are covered by cash flow reports. However, accounting income reflects the total profits and losses that businesses report from their operational activities.
Importance of accounting income on the cash flow statement
Accounting income and cash flow are related because a company’s statement of cash flows can be impacted by net income. For instance, even though the business won’t receive payment until later, when a company sells to a customer, it records the transaction in the accounts receivable at the time of the transaction. The transaction is still reflected in the business’ income statement, but cash receipts and payments have an impact on the company’s cash flow.
The first line item on the cash flow statement is the accounting income, which represents the cash available for a business to reinvest in operational procedures and pay dividends to shareholders. As a result, the company’s accounting income plays a significant role in determining its financial situation.
FAQ
Why is cash flow more important than accounting income?
When a debt is settled or the company experiences an increase in revenue, the cash flow turns positive once more. In this instance, cash flow is more crucial because it ensures that the company remains operational and profitable.
Why is accounting net income different than the company’s cash flow?
Cash flow from operating activities (CFOA) is a measure of, in part, the cash coming in and going out during a company’s regular business operations. Net income is the profit a company has earned for a period. The starting point for calculating cash flow from operating activities is net income.
Why is accounting income not the same as cash flow give two reasons?
Because an income statement includes non-cash items, accounting income is not the same as cash flow. Non-cash items, such as depreciation, are costs billed against revenues but have no immediate impact on cash flow. 2. (The deduction or depreciation is just an accounting figure; actual cash spent is not reflected there.
What is the difference between accounting income and cash flow quizlet?
Accounting income is purely revenue – expenses = income. Cash movement occurs when money actually exchanges hands, either when it enters or leaves.
