Accrual Earnings Versus Cash Flow as a Performance Measure

Keep in mind that accrual earnings (net income from the income statement) do not necessarily reflect cash flows. Many revenue and expense transactions have no immediate cash flow effect. Nevertheless, net income is a very useful performance measure. It reflects accomplishments by the firm (such as credit sales that will subsequently result in cash inflows) as well as resources consumed by the firm in generating revenue (for example, employee salaries that remain unpaid at the end of a period).

If net income is a useful performance measure, why is cash flow information needed? An analogy to baseball can be drawn.Many aspects of a baseball player’s performance are measured. For example, home runs measure power hitting, while on-base percentage reflects the ability to reach base safely. Similarly, earnings and cash
flows are different performance measures of a business organization.They should be viewed as complements, rather than substitutes. Each measure contains information not necessarily reflected in the other. In particular, the statement of cash flows provides information about a firm’s liquidity and financial flexibility (the ability to respond to unexpected events by altering the amounts and timing of its cash flows).

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