WHY CASH FLOW IMPORTANT
Suppose Atul is an entrepreneur who stalls a Panipuri shop near a park, where lots of people gather morning and evening.
Initial capital provided by a friend Nirmalji
Cash :Rs 1000
Inventory (means pani, pakodi, masala etc) :Rs 500
Kitchen equipment :Rs 500
TOTAL :Rs 2000
LIABILITY AND EQUITY
Nirmalji Debt(interest free) : Rs1900
Atul (Own savings) :Rs100
First day Atul manages to sell 200 plate Panipuri @10, while cost per plate Rs 1
So he manages to get profit of Rs 9
ACCRUAL INCOME STATEMENT
Cost of Sales: Rs 200
Profit: Rs 1800
Since Atul wanted to get market share so he allows customers to pay on credit next day when they come.
90 out of 200 plate are purchased by such people who don’t carry cash while visiting park.
So even if Sales 200 plates the actual cash comes around 110*10=Rs 1100 Only.
CASH FLOW STATEMENT
Cash Sales: Rs 1100
Cost: Rs 200
Net Profit :Rs 900
So while in accrual accounting net profit is Rs 1800,
The real profit is only Rs 900.
If the people who purchased on credit didn’t come next day then it would be written off in accounts.
So if this type of business to be continued then a time will come when business faces financial distress.
Thats why CASH FLOW STATEMENT MOST IMPORTANT FOR A BUSINESS.