iTEP Reading Part 1
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Accounting and Cash Flow

One of the most overlooked determinants to a business' success is the cash flow of that business. While the business may show a large net income on its income statement, how much of that net income has been received in cash is important. Many companies show large amounts in their sales figures, but key questions to ask are, "How much of these sales resulted in cash and how many of the sales were charged to the accounts receivable account?" and "What are the exact contributions and deductions to the cash account?"

Prior to 1988, the Financial Accounting Standards Board (FASB) did not see the merit of a cash flow statement. At that time, pro forma statements required for disclosure included the income statement, the owner's equity statement, and the balance sheet. After 1988, adjustments were made and the cash flow statement became a required element of the pro forma statement package.

There are several ways in which a properly prepared cash flow statement can help identify elements critical to a company's success:

  • It can provide a reality check in situations where companies have an incentive to bias the accrual accounting assumptions.
  • It offers a one-page summary of the results of a company's operating, investing, and financing activities for the period.
  • It forces the preparer and users to analyze a company's use of its assets and liabilities and Compare these findings to previous periods.

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A cash flow statement was strictly optional.

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