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 ...view middle of the document...
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 decisions affecting the future of a business?
Both the income statement and the cash flow statement are vital documents since they tell what has happened in the past, but are very limited in being able to predict the future. By studying trends over longer periods of time (years) you can discern the direction in which a company is going and develop a forecast plan. If the trends have continued going in one direction or the other for many years then these financial statements are a bit more reliable in predicting the near future. However, past performance, whether good or bad, is not necessarily the best predictor of what will happen in the future. Other limitations to consider are:
• The more out of date the statements are, the less valuable they are.
• Without editorial notes, creditors cannot get a clear picture of the credit risk they are considering.
• Unless the company’s statements are audited there is a high probability that they may be misleading or fraudulent, often times unintentionally.
• They are limited to accounting data only meaning that it does not take into account any other factors that might affect its future growth.
• Fiscal years end at different times making it extremely difficult to equally compare companies.
• The accounting methods utilized vary making it difficult to compare companies.
Despite the many limitations of these financial statements, they are useful in evaluating the current financial position of the company, making financial projections, attracting potential investors, and paying taxes.