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Finally, there is the cash flow statement. To the person unfamiliar with financial statements this appears to be almost identical to the income statement. I'll explain the difference, but let us first understand what this statement conveys. The cash flow statement is the simplest to understand in that it shows the flow of cash into the business in the form of receipts and the flow of cash out in the form of cash disbursements. The result is net cash flow. If you have more money coming in than going out that is called positive cash flow. If more money goes out than comes in you have negative cash flow.
Entrepreneurs become so confused when looking at an income statement and a cash flow statement side-by-side. Remember your definitions above. On an income statement sales refer to the point in time the sale is actually made. Receipts on the cash flow statement reflect when you actually collect the money from that sale. Cash businesses (retail being a typical example) can realize the sale and collect the receipts at the same time, and the transaction shows on both statements in the same month. Expenses on the income statement reflect when you actually incur the expense. A cash disbursement on the cash flow statement is when the expense is actually paid.
Another common distinction between the two statements is often reflected by the inclusion of depreciation against fixed assets and interest expense on a loan in the income statement. On the cash flow statement you don't see depreciation, but you notice payment on a loan, which includes principal and interest. You have to remember the income statement reflects how you use assets (in the form of expenses) to generate sales. Depreciation is the expense on fixed assets used in the operation and sales activities of the business. Interest expense is the cost of the money borrowed. The money you borrow becomes cash on hand in the bank until you spend it.
To better understand these definitions review the Small Business Administration library examples. The samples at the bottom of the page are an excellent example of financial statements for a small business. There's no mystery to reading financial statements. You merely have to learn how to read them, how the 3 statements are interrelated, and how they provide you a comprehensive overview of your company's financial performance.
© 2000, Carroll Stephen Windhaus
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