Discussing the three Financial Statements.

Profit & Loss statement

This is a statement that records the income of the business (whether all received or not), as well as the expenses of the business (whether all paid or not). It determines what the profit or the loss of the operation is for a particular period, by deducting all costs from income.

The problem with the P&L is that at the end of the year the profit is not actually cash. This is because parts of the profit & loss account are made up by assumptions.

Cash-flow statement

Unlike the P&L the cashflow statement has nothing to do with income and expenses, but has everything to do with cash flowing in and out of the business. Cashflow has nothing to do with profit; they are two different types of concepts. Cashflow is mainly concerned with cash balance at the end of a particular period, for example every month.

There is an argument that cashflow statements are more useful then the other two financial statements (Balance sheet and Profit & Loss). I can understand why a person may argue that; this is due to numerous reasons, such as:

• A P&L statement may show a positive figure at the end of a particular period, but that does not mean the business has made a profit in terms of cash due to the fact that parts of the P&L account is made up by assumptions. For example, the business is assuming that they have paid insurance, when they haven’t. But in the P&L account it will show that the business has paid the insurance, hence the profit figure will be different. Where as in the cashflow statement, the transaction is recorded after the event has taken place. The bottom line is that, regardless of the transaction taking place or not the P&L statement will state that the transaction has or will take place.
• Like the P&L statement, the balance sheet also makes assumptions. For example, as discussed earlier, assets are valued at cost, and one may not be able to determine the value of the assets in the future, hence assumptions are made for valuation of assets.
• Unlike the P&L and balance sheet, the cashflow statement intended’s to include information that represent an adequate picture of the business’s liquidity and financial adaptability.
• The balance sheet and the P&L are used to assess the financial situation of the business but this may be misleading due to only parts of the financial activities are recorded, where as the cashflow statement presents the reader with additional information that can be useful.
• As both balance sheet and P&L statements use the accruals concept it is difficult for the user of the accounts to investigate whether a business has a good cash management system, which is very important to the success of the entity.

It may be that the cashflow statement presents transactions that have occurred, compared with the P&L and the balance sheet where transactions are assumed to take place. It is better to use all statements together to present a fuller picture of the business to the user of the accounts. Like the P&L and balance sheet, the cashflow statement has few deficiencies. For example, cash can be manipulated, as a business you are bound to juggle around with payments if there is a problem in order to make the cashflow available, and therefore manipulation can take place. Also the technical side of cashflow statements has room for improvement. The requirements to include both receipts and payments under the same heading frequently results in a statement which is riddled with brackets and therefore difficult to understand.

References

Text:

Advance Financial Accounting, Lewis, R & Pendrill, D, forth edition, 1994.

Financial Statement Analysis, Gibson, C H, forth edition, 1989.

Financial Statement Analysis, Bernstein, L A, fifth edition, 1989.

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Analysis