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Understanding the Difference: How to Use the Income Statement vs. Cash Flow Statement in Your Growing Business

The Income Statement and Cash Flow Statement are two financial tools that are used to guide several different aspects of the operations of any growing business. Now, if you are a business owner and don't already have an accountant providing these statements, you should consider getting one or learning how to analyze your company's financials so that you can take advantage of how they can help you.

Either way, let's start by explaining each statement so that you have a basic understanding of how these financial statements are calculated and what they are used for.

The Income Statement, otherwise known as the Profit and Loss Statement (P&L), is a look at the income and expenses of a company, over a set period of time (i.e. fiscal year). These transactions can be cash and non-cash in nature, and are represented in different sections that focus on the major categories of the business.

How to differentiate the cash flow statement and income statement
How to differentiate the cash flow statement and income statement

Before we go in to detail, you should understand that there are two different ways to calculate the Income Statement, the cash or accrual accounting method.

From a high level, cash means the cash that came in and out of the business's door. With accrual, we are calculating what we are owed and what we owe, whether we have received or paid for these items yet or not. If you would like to understand these accounting methods further, go check out the post I did on accrual versus cash accounting.

Usually located at the top of the P&L is the Revenue section. This is where you can see the dollars made from each of your different revenue generators and can be as detailed as you want. What I suggest is to have, at least, the main categories of revenue as accounts on the P&L. Having the revenue broken down further can be even more valuable, therefore, you really want to understand the revenue structure so you have a clear view of what money is entering your establishment and what makes sense to pay attention to and measure.

The next sections represent the expenses of the company. Cost of Goods Sold, Operating Expenses, and Other Income/Expense are the main categories of this part of the Income Statement. Again, these accounts can be as detailed as you need them to be so make sure to recognize how the expenses are laid out in your business and design the accounts accordingly.

There is much more to be had with the Income Statement than just filing taxes. As the accountant, I am able to identify trends, measure Key Performance Indicators (KPIs), study the differences between periods, analyze profit margins, and be able to build future budgets because of this information.

Furthermore, this type of data is beneficial because it identifies issues and/or successes of the business model. If the model is running well, the Income Statement can lead to improvements which can add to the bottom line. Inversely, if the business is not producing results, the Profit and Loss can help identify where the issues are.

To start a bridge to the Cash Flow Statement, note that the Profit and Loss Statement has transactions that are not cash in nature yet (accrual method). The opposite is also true, that there are cash transactions that do not hit the Profit and Loss Statement, but do hit the Cash Flow Statement.

Let's look at a loan's payments as an example. When the loan is established, the amount owed is put on your Balance Sheet in the Liability section. Every month going forward you are making a payment, but only a portion of that payment is going to hit the P&L, the interest expense. The other part of the payment, is hitting the principal which is represented on the Balance Sheet. Point being, not all of that cash payment will be recorded on the P&L.

Therein lies how the two statements differ. Not all cash transactions are on the Income Statement and not all transactions on the Income Statement, are cash related. Confusing yes, but both financial statements have valuable purposes and are constructed in a way that correlates to accounting's double entry foundation.

Now for the easier of the two financial statements to understand. The Cash Flow Statement is exactly what it says, it is a report that shows how the cash moves through your growing business.

There are two methods to calculate the Statement of Cash Flow, Direct and Indirect.

A Direct Cash Flow Statement is simple, it shows the money coming in, and money going out which are broken into sections that correspond to the type of business you are running.

The Indirect method, below, is more complex and is not worth the brain damage explaining it. Basically, the statement works back from Net Income and adds or subtracts the changes happening on the Balance Sheet.

Cash Flow Statement

The ultimate goal of the Cash Flow Statement is to show you exactly how cash is being spent and earned in your business.

One important measure that any business owner would want to know is if the business is producing enough cash to cover its expenses. This comes from the Statement of Cash Flows!

The other way I use this statement is to project cash balances out in to the future. Since this accounting tool can be looked at, on a monthly basis, I can use the history of cash, combined with current variables, to forecast where the cash balance is going to be a day, a month, or years from now.

Where would this be valuable? Let's say you want to expand your business to another location but you don't know if you can afford to do that. Working with a Cash Flow, you can reasonably plan for a certain amount of cash to be available. The next question that enough? From here we start getting into financing activities such as taking out a loan to cover the expansion.

My last question is this...if you are a business owner, do you have the talent, or a person that is professionally trained in accounting, able to build an accounting system that creates these reports and, even more importantly, the understanding to be able to derive value from them?

As a Fractional CFO, I use both of these financial statements to analyze the business, develop KPIs, teach my clients what is happening with their businesses, and how to improve profitability. Even better, when we combine, and analyze the major financial statements; Balance Sheet, Income Statement, and Statement of Cash Flows, we begin to understand all facets of your business.

With the help of your Fractional CFO, the final step in the process is to develop a month end package that takes all of this data and breaks it down into usable information to make decisions from.

Blue Collar CFO

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