I've been running a series of posts on the theme of managing yourself like how you would run a company. There are three important financial statements to report to regulating authorities or to investors; these are the income statement, balance sheet and cash flow statement. I've already commented on the first two. The links are listed below:
1. Running yourself like a company - income statements
2. Running yourself like a company - balance sheet
The third one, cash flow statement, is really important in a company because of the way the income statement is derived. The report is prepared under the accrual basis of accounting, hence as long as the sales/services are fulfilled by the company, there will be an credit to the income. Since it's normal to give customers credit, the actual payment of the goods and services might not come in until a while later, thus whatever increment in income reported reported is essentially 'on paper' only with no corresponding increment in cash received. That's why it's important to see the cash flow statement because however healthy your reported income is, it's ultimately cash that is king.
You find that when you are preparing your own income statement, it's unlikely to be prepared under the accrual basis of accounting. Most likely, when you receive your salary, you receive it in cash or cash equivalent. In other words, you don't report that salary as your income until you received it in cash or in your bank account. Likewise for dividends and all other cash items like paying for your food and other stuff. Hence essentially, your personal income statement can also double up as your cash flow statements. They are not that different.
There are some things that you might use an accrual basis to record down your spending though. For credit cards, let's say you spend $100 on a restaurant dinner today but your credit card bill payment only comes a month later. Do you record your expenses for $100 on food today or do you record $100 on food a month later when you actually pay the bills? The question boils down to whether you record the amount spent when the services/goods are received or when the bills are paid. There's no right or wrong answer, because ultimately, it's your system we're talking about here. For me, I'll record when the services or goods are received for credit card expenditures. This makes my income statement a little different from my cash flow statement, if I am to compare between the two.
But it's not a big deal though. I used to have a separate income statement and cash flow statement, but I no longer do that. That's because my income, at least in the past, are recorded when the services are given out but not paid to me. I'm a tutor, so when I give lessons, I don't always get paid on the spot. Usually there's a credit period of roughly 2 weeks to 1 month before I received cash payment for the services rendered out. However, I realised that while it serves no purpose having two such statements, it certainly adds to the work I've to do. After 10 years, I scrapped that system.
I'm happy with just one income statement on the basis that :
1. Income is recorded only when I received cash. Works the same for dividend and interest received; I only record them when I received it.
2. Expenses are recorded when I paid for them, or when I received the goods/services, whichever is earlier. E.g. If I buy a shirt for $10 using credit card but only pay the shop a month later, I'll still record the $10 that I spent today. If I buy a shirt online for $10 and paid them today, but I can only receive the shirt a month later, I'll record the $10 now too.
3. Loans/mortgages: The day that I pay my monthly loan amount, I'll record it down.
The last and (possibly) final post on this series will still be on cash flow. I'll be posting my thoughts on looking at the stream of cash outlay that occurs monthly over a period of one year. Having this idea will help you to plan ahead so you'll never be caught with a huge monthly cash outlay that you knew about but forgotten.