Basic Accounting:
Income Statements and Budgets

Of all the reports that are a part of the Financial Statements set, perhaps the Cash Flow Statement is the most reliable in attempting to establish budgets and manage operating cash on a realistic basis.  Although it is discouraged, business practices sometimes mask the reality of the truth when putting together the Financial Statements.  There is one fact that you cannot, however, dispute.  The Cash Flow Statement cannot lie, you either have the cash or you don't.  How does the Income Statement figure into the budget picture?

In order to remain open and operate, a business must have the necessary operating capital.  The necessary operating capital is also known as their cash on hand; the Statement of Cash Flows is a review of the fluctuations in cash levels in operating, financing, and investing areas.  A review that reveals shortages, doesn't speak well for the upcoming year, when creating budgets that are planned to exceed the prior year's expenses. 

Operating capital or cash is the life's blood of a business.   Cash is used to pay bills, make investments, and to pay salaries for the employees providing goods and services on behalf of the company to the company's customers.  The adequate allocation of cash for operating expenses and covering day to day operations needs is essential to a business that wishes to remain in business.  This is where you can begin to see the importance of the Income Statement. 

When a company begins to establish budget guidelines for the upcoming business year, a review of the financial statements, especially the Statement of Cash Flows will provide an accurate picture of the actual flow of cash through the business, over the course of the last year.  The Income Statement will provide a monthly picture of prior income and expense for the preceding years.   Steady, consistent numbers indicate that there is sufficient cash flow and management in place to operate the business in a steady, smooth manner; this allows for long-term profitability and growth.  The bottom line of the Income Statement is an indication to analysts of efficient company operations.  How efficiently can the business produce and sell its primary product or service? 

Yet unlike the Income Statement, the Statement of Cash Flows strips away all the expense items like depreciation and other non-cash accounting expenses, so that you get a true picture of exactly how much clear money the company actually generated over a given period of time.  This is the real figure that must be obtained in order to set budget levels and expenditures for the upcoming year and this is a combined review of the Income Statement and the Statement of Cash Flows. 

This is a wonderful example of the way in which the entire set of financial statements is needed to give accurate pictures for different purposes.  Each need that is fulfilled by the review of the financial information of a business will pull different information from different reports.  The budget needs of a business are a wonderful example of the interdependence of the reports.

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.