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Statement of cash flows

The need for a statement of cash flows

Whilst a business entity may be profitable this does not mean it will be able to
survive. To survive an entity needs cash to be able to pay its debts. If an entity could
not pay its debts it would become insolvent and would not continue to operate.

The main reason for this problem is that profit is not the same as cash flow. Profits
(from the statement of profit or loss) are calculated on the accruals basis. Goods and
services can be sold on credit so revenue is recognised but cash is not received
immediately. Goods and services purchased are shown as an expense in the
statement of profit or loss but cash is not paid immediately. There are also a number
of expenses that are recognised within profit calculations but which have no cash
impact e.g. annual depreciation charge.

Therefore, it is possible for an entity to be profitable but have insufficient cash
available to pay its liabilities when they fall due.

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