How Do Interest Expenses Affect Cash Flow Statements?

As a business owner or manager, you have probably reviewed each of your company's primary financial statements – the income statement, balance sheet, statement of owner's equity and statement of cash flows – to gauge your company's fiscal well-being. What may not be apparent from a review of these documents is how they relate to each other. For instance, the interest expense reported on your company's income statement reduces the amount of cash recorded on the related cash flow statement.

Cash Flow Statement

The cash flow statement uses information from your company's income statement and balance sheet to show whether or not your business succeeded in generating cash during the period defined in the report's heading. Put simply, your company's cash flow statement demonstrates how your business generated and used its cash. Your cash flow statement will present your company's cash inflows and outflows as they relate to operating, investing and financing. The final line of the statement of cash flows will reveal whether your business experienced an increase or decrease in cash in a defined length of time.

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Operating Activities in the Cash Flow Statement

The operating activities section of your company's cash flow statement determines whether the net profit or loss reported on your income statement has increased or decreased the amount of your company's cash flow. Because your income statement is most likely prepared using the accrual method of accounting, the operating activities section of your company's cash flow statement will present the bottom line recorded on your income statement so it only includes the revenues that were actually received and the expenses that were paid during the weeks or months accounted for in the cash flow statement.

This means your company's interest expense will only reduce the amount of your company's cash flow to the extent that your business laid out cash to cover the expense.

Interest Expense on the Income Statement

Since the net profit or loss reported on your company's cash flow statement already accounts for the interest expenses your business paid during a given period, the amount paid will not appear as a separate line item on your company's cash flow statement. Instead, the amount of interest expense your business incurred will appear as a line item on your income statement under the category "Non-Operating or Other."

Loan Recording Principle

Even though interest expense lowers your cash flow and is recorded in the operating activities section of your company's cash flow statement and in the nonoperating expenses of its income statement, the balance of the loan your business took out and the principal payments it makes on the loan are only recorded in the financing activities section of your company's cash flow statement.

The loan amount and principal payments made on it do not appear on your company's income statement, because borrowed money is not considered income generated by the sale of your company's goods or services even though the loan and the payments made on it affect the amount of your company's cash inflows and outflows.

References

• Accounting Coach: Cash Flow Statement
• Accounting Coach: Income Statement
• Accounting Coach: Where Is Interest on a Note Payable Reported on the Cash Flow Statement?
• Reference for Business: Cash Flow Statement
• Securities and Exchange Commission: Beginners' Guide to Financial Statements

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