Purpose: To help you understand the importance of cash flows in the operation of a small business.
You have just received your year-end financial statements from your accountant and you notice one very disturbing item. The net income from your income statement shows $40,000! Your very first thought is “Where is it?” Then you look at your cash balance and see that it decreased $10,000 from last year to this year. You’re thinking there has to be something wrong here. So you call up your accountant and ask for a meeting to discuss this obvious error. After all, how can you possibly have a positive net income and have your cash balance decrease?
At the meeting, the accountant lays out the financial statements in front of you and begins to explain how this would have happened. The following is a condensed income statement, statement of changes in equity, and statement of financial position.