How are the income statement and statement of cash flows used to make business decisions?
The income statement reflects the company's financial performance by showing how much money was generated (revenue), how much was spent (expenses), and the difference (profit) between the two over a period of time. It is divided into the operating and non-operating sections. It can also tell how much money shareholders would receive if the company were to distribute all of its net earnings.
The cash flow statement provides cumulative information regarding all cash inflow from both its ongoing operations as well as any external investment sources. The cash flow statement is not influenced by any kind of fancy accounting concepts. It is a true reflection of the company's operating, investing, and financing activities. It helps to show why the company either lost or gained money during that particular period in time.
The statement of cash flow parallels the income statement by showing the relationship between the net income and cash flow. The income can be increasing but the cash flow decreasing if the company is not actually collecting cash from its customers. The income statement can tell you whether the company made a profit while the cash flow statement tells you whether it actually generated any cash.
Put very simply, the income statement answers the question "How did we do?", while the cash flow statement answers "Where did the money go?".
Three main groups use financial statements:
1. Large corporations - to decide how much credit to give to customers and how much should be distributed to investors in dividends.
2. Investors - to decide whether or not it would be to their advantage to invest their money and how much should be invested. They determine current profitability and make an attempt to predict the future.
3. Government - to determine how much the company must pay in taxes.
What are the advantages and limitations of using them to make...
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