The Disadvantages of Income Statements & Statement of Cash Flows

by Nola Moore

The income statement and statement of cash flows are two of the major financial reports that make up corporate communications to shareholders. Both reports can reveal a lot to investors about the financial state of a company. Just as important, however, is what those reports can't tell you, and how each makes up for the other's shortcomings.

Function of the Income and Cash Flow Statements

The income and cash flow statements are very similar at first glance, since both report how money moves into and out of a company. The income statement does this on an accrual basis -- reporting the income earned during the period and the expenses associated with earning that income. The statement of cash flows is the checkbook, reporting cash received and cash spent during the period.

Disadvantages of the Income Statement

The biggest disadvantage to the income statement is accrual accounting. While this does help to directly relate income and expenses, accrual accounting is about the timing of work, not the timing of payment. In most businesses, this means delaying expense recognition while recording income before there is cash in hand. In a healthy business this isn't a problem, but the income statement can mask a struggling business or shady accounting practices.

Disadvantages of the Cash Flow Statement

The cash flow statement, on the other hand, is all about showing the money. While the cash flow statement does a good job of showing whether or not a company can pay its bills, it doesn't link business activity to the income it brings in. This can make it hard to see how efficiently the company makes money. It can also be difficult to connect expenses to income when the two things are separated by several months.

Benefit of Dual Reporting

It should be fairly obvious that the deficits in the income statement are somewhat alleviated by the cash flow statement and vice versa. It's important to remember, however, that both reports are periodic -- they only reveal activity for one quarter or one year. You can compensate for this by reviewing the reports over several periods or even several years.

About the Author

Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.