As we all know, the net income and cash flow of a company are two important aspects we will focus on when we want to evaluate the financial position of that business. However, do you feel confused about the relationship between them? Some will think that both carry similar meanings as they involve cash. If you are one of them, this article may be able to provide you with some insights about their differences.
Net income is the amount of money the business has earned in an accounting period after deducting all the expenses incurred in that period. On the other hand, cash flow is the net amount of cash the company has generated in a specific timeframe. One should minus the sum of cash outflow from the sum of cash inflow to arrive at the cash flow.
So, how does net income differ from cash flow then? Let us take XYZ Corporation as an example. From the perspective of the profit and loss statement, if the revenue and expenses for an accounting period were RM25,000 and RM18,000, respectively, its net income will be RM7,000 (RM25,000 – RM18,000). From the perspective of cash flow statement, on the contrary, the elements that we should look at is the cash inflow and cash outflow during the year. Let’s say the cash inflow of the company was RM30,000 and the cash outflow was RM22,000. To calculate cash flow, deduct cash outflow from cash inflow, and the resulting amount is RM8,000.
When we are calculating net income, we will not focus on whether the transactions are in cash, and what we will do is to record the revenue in the income statement once we earn them. As against, in the case of the calculation of cash flow, we will only account for cash and cash equivalents. Apart from that, some of the expenses that we have included in the income statement are non-cash expenses, yet we still deduct them from the company’s revenue. Some common examples include the depreciation and amortization expense. However, when we are dealing with the cash flow statement, we should add them back, and they will not bring any impact to the cash flow statement too.
Also, from the example mentioned above, we can see that the amount of net income and cash flow can be different as the sums that we would use to account for them are different too. This example also showed that net income should not be the only aspect to consider when we are analyzing the financials of a business. The statement of cash flow can help investors to recognize the company’s cash inflow and outflow so that they will not only focus on the attractive profits the business has made. This is because negative cash flow is not a piece of good news, even though the company has earned a considerable profit. Therefore, investors will not be able to know the exact financial position of a company without looking at its statement of cash flow.
Having a positive bet income and positive cash flows is an ideal state for a business as this indicates that the company has strong product lines and has high profitability. This also means that the business will most probably have a consistent profit margin. Besides, this means that the amounts of impairment losses, sale and disposal of assets (Also see Understanding Asset Conversion Cycle) and write-offs are insignificant to the company’s revenue. For companies that have negative net income and negative cash flow, the revenue that their business activities have brought to them may be insufficient to cover its expenses. This means that their profit margin is very thin, and the business is losing money rather than making a profit.
Both net income and cash flow are important metrics that people would look at when they are analyzing the financial position of a business. If you want to calculate them, accurate and timely accounting (Also see Are Accounting Treatments for Profit and Non-profit Organisations the Same?) records are mandatory. If you are new to the world of business and you do not know much about accounting (Also see Work in Process Accounting), hiring an accounting firm in Johor Bahru can be the right choice. The experts will be able to manage those tasks for you without costing (Also see Differences Between Financial Accounting and Cost Accounting) you much so that you can have more time and energy to expand your startup.