Cash basis accounting can produce a misleading short-run picture when, for example, current receipts represent payment for provision of future goods and services. Auditors therefore insist that publicly owned companies prepare statements on an accrual basis. The problem with such statements is that they confound the effects of accounting judgments and allocations with the effects of more concrete transactions.

To predict a corporation’s future cash flows, an outside user requires a clear picture of the company’s operating receipts and expenditures and past flows to and from debt and equity suppliers. Traditional statements do not provide this information, even if the outside user utilizes all the available footnotes. The authors’ proposed Financial Flows Statement does.

While the Financial Flows Statement provides a clear picture of cash flow from operations, the authors’ Earnings Reconciliation Statement segregates the adjustments that produce accounting net earnings into three different levels — adjustments requiring little judgment, those requiring some judgment and pure accounting allocations.

Accrual accounting necessarily involves judgments, and some of them will inevitably be poor. While they cannot prevent poor judgment, the authors’ statements permit the outside user to assess the correctness of these judgments for himself.