Why doesn’t an income statement provide a measure of a firm’s cash flo

Why doesn’t an income statement provide a measure of a firm’s cash flows?

What will be an ideal response?

ANSWER

An income statement is not a measure of cash flows because it is calculated on an accrual basis rather than a cash basis.
In accrual basis accounting, profits are recorded when earned–whether or not the profits have been received in cash
–and expenses are recorded when they are incurred–even if money has not actually been paid out. In cash basis
accounting, profits are reported when cash is received and expenses are recorded when they are paid.
For a number of reasons, profits based on an accrual accounting system will differ from the firm’s cash flows. These
reasons include the following: 1. Sales reported in an income statement include both cash sales and credit sales. 2.
Some inventory purchases are financed by credit, so inventory purchases do not exactly equal cash spent for inventory.
3. The depreciation expense shown in the income statement is a noncash expense.