Hi there, please can you help me with my accounting H.W? I just want to know why retained earnings is not included in the cash flow statement?

Remember that cash flow is the measure of money (cash) that comes in and goes out. Think of it as a check book - if you write a check to somebody then money flows out; if you receive a check then money is flowing in. With retained earnings there is no check being writteen to anyone, nor are you receiving any extra cash from anyone. Hence it does not affect cash flow.

You also need to think about what goes in and out of retained earnings. The only things that affect it are net income (or loss) and dividends declared.

Net income isn't cash flow - it's just whatever is on the income statement, and you're trying to report cash, not the "on paper" income statement.

While dividends end up (usually) getting paid in cash, that's the dividends you're considering, not the entire retained earnings. There can be lots of accounts like that for which it's not the account itself that goes on the cash flow, but rather something that may affect that account. There's a difference. And even in the case of dividends, stock dividends have no cash. Cash dividends have cash, but what comes out of retained earnings is dividends declared, not dividends paid. The cash flow wants the dividends paid. They may or may not be the same number.

Therefore ultimately in the end, while you may want to "account for" what happened in retained earnings and need some of those numbers, the only one thing that ends up on the cash flow is dividends paid.

And why we are advised to use indirect method than direct method in preparing cash flow statement?

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Originally Posted by fahmy

Hi there, please can you help me with my accounting H.W ? I just want to know why retained earnings is not included in the cash flow statement ?

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The reality is retained earnings are represented in the various components of the Cash Flow Statement when taken over more than one accounting period. It is just that a Cash Flow Statement is not about earnings but Cash Flows and you must learn the difference. Certain parts of the earnings statement are not representative of current cash flows