The profit/loss of companies for a given year is shown in the income statement, which forms part of simplified or annual financial statements prepared during the annual closing. According to the Accounting Act, the results of business activities can be established with either the total-cost or the cost-of-sales method. In the case of companies preparing financial statements, a cash-flow statement is a mandatory part of the supplementary notes, presenting the changes in liquid assets. For statements that form part of the financial statements, the structure and minimum required breakdown of both the income statement and the cash-flow statement including the profit/loss under the cash-flow approach are defined in advance.
Interim reports can also be prepared with a cash-flow approach
Most companies prepare interim reports with a form and structure showing the company’s typical income and expenses appropriately. An interim report may be prepared on a profit/loss or a cash-flow basis, depending on what types of decisions need to be supported. The basis for interim and annual reporting is always the data recorded during bookkeeping. When keeping double-entry books, true, continuous and transparent records are kept of the company’s assets and liabilities as well as the changes therein, in a closed system.
By contrast, when keeping single-entry books, the company only keeps records of the liquid assets it owns along with their liabilities, so the recognised profit/loss and the change in liquid assets are largely the same. Use of the latter is significantly limited, so for the vast majority of companies there is a difference between the profit/loss recognised based on double-entry books and the cash-flow-based result (i.e. the change in liquid assets).
How can amounts recognised under the cash-flow approach and the profit/loss approach be reconciled?
The profit/loss approach and the cash-flow approach can be connected via an “indirect cash-flow statement”. When preparing the indirect cash-flow statement, starting with the company’s profit/loss we eliminate the items that do not involve any cash movements, and take into account the impacts of changes in the individual balance sheet positions. For example, if a company’s receivables have risen, we have to decrease the accounted profit by the amount of the increase. The growth shows that our receivables have risen, so recognising growth in profit is not justified based on the cash-flow approach. We can say the same about a company’s liabilities, just in reverse: in this case, we probably accounted higher costs due to the increase, but these costs have not yet been financially settled, so we increase our profit/loss to establish the actual change in liquid assets.
One further reason for the differences between profit/loss recorded on an accounting basis and the changes in liquid assets can be an increase of capital, a decrease of capital, a borrowing or a repayment, etc. We have to treat the effect of tangible asset movements on profit/loss and liquid assets appropriately.
If a company’s profit/loss recognised according to the rules of double-entry bookkeeping and the changes to liquid assets show a significant difference, reviewing the reason for the difference is justified. If this analysis is also important for the owners of the company, they may prescribe the preparation of regular interim reports, which include cash-flow-based calculations of profit/loss.
