As a business owner, you’re likely familiar with the statement of cash flows (SCF), which is a financial statement that summarizes a company’s cash inflows and outflows for a specific period. However, you may be wondering whether the SCF is prepared on an accrual basis or a cash basis. In this article, we’ll explore this question in detail, discussing the key differences between accrual and cash basis accounting, how the SCF is prepared, and whether it’s based on accrual or cash basis accounting.
What is Accrual Basis Accounting?
Accrual basis accounting is a method of accounting that recognizes revenue and expenses when they are incurred, regardless of when cash is actually received or paid. This means that revenue is recognized when it is earned, regardless of when the customer pays for it, and expenses are recognized when they are incurred, regardless of when the company pays for them.
Accrual basis accounting is widely used in the business world because it provides a more accurate picture of a company’s financial performance over a given period. By matching revenues and expenses to the period in which they were incurred, accrual basis accounting provides a more comprehensive view of a company’s financial health.
What is Cash Basis Accounting?
Cash basis accounting, on the other hand, is a method of accounting that recognizes revenue and expenses when cash is received or paid. This means that revenue is recognized when cash is received, and expenses are recognized when cash is paid out.
Cash basis accounting is generally only used by small businesses and individuals, as it is much simpler than accrual basis accounting. While it may be easier to understand and maintain, cash basis accounting can provide a misleading picture of a company’s financial health, as it does not take into account revenue and expenses that have been incurred but not yet paid.
How is the Statement of Cash Flows Prepared?
The SCF is prepared using the indirect method or the direct method. The indirect method starts with net income and adjusts it for non-cash transactions and changes in current assets and liabilities. The direct method, on the other hand, lists actual cash inflows and outflows from operating activities.
Regardless of the method used, the SCF is prepared using cash basis accounting. This means that only actual cash inflows and outflows are included in the statement. While the SCF may provide insight into a company’s financial health, it does not provide a complete picture of its financial performance, as it does not take into account non-cash transactions.
FAQs
Q: What is the purpose of the statement of cash flows? A: The purpose of the SCF is to provide information about a company’s cash inflows and outflows for a specific period.
Q: What is the difference between the indirect method and the direct method of preparing the SCF? A: The indirect method starts with net income and adjusts it for non-cash transactions and changes in current assets and liabilities, while the direct method lists actual cash inflows and outflows from operating activities.
Q: Is the SCF prepared on an accrual basis or a cash basis? A: The SCF is prepared on a cash basis, meaning that only actual cash inflows and outflows are included in the statement.
Q: Why is accrual basis accounting preferred over cash basis accounting? A: Accrual basis accounting provides a more accurate picture of a company’s financial performance over a given period, as it matches revenues and expenses to the period in which they were incurred.
Q: Is it possible for a company to use both accrual and cash basis accounting? A: No, a company must choose one method of accounting and use it consistently.