Why Are Net Income and Cash Flow from Operating Activities Different?

Why Are Net Income and Cash Flow from Operating Activities Different?

It’s important for businesses to understand cash flow. Cash is what keeps a business operating smoothly. You obviously need profit, but equally as critical is your cash flow. You must have a firm understanding all the financial facets of your business, from net income to cash flow from operating activities. Here are the basics.

What is Net Income?

Net income is the mathematical outcome of gains and revenues, minus the cost of products and solutions sold as well as losses and expenses. Net income appears on your income statement as a net gain. If the net amount is negative, it is referred to as a net loss.

What is Cash Flow from Operating Activities?

Cash from operating activities is net cash inflow documented in the first section of cash flow statements. Cash from operating activities is focused on the outflows and inflows from primary activities such as providing services, buying and selling merchandise, etc.

Cash from operating activities doesn’t include the amount of money spent on capital expenditures such as new facilities or equipment, cash garnered from the sale of long-term assets or cash utilized for other long-term investments. `

Here’s How They’re Different

Net income and cash flow from operating activities are different for many reasons.

  • Reason #1: Cash flows from operating activities include specific items that are addressed distinctly on the income statement. Non-cash expenses, including depreciation, share-based compensation and amortization need to be included in order to calculate net profit. These types of expenses are incorporated back into net income on the associated cash flow statement. They reduce net income but do not affect net cash flows.
  • Reason #2: Net income is a line item found in the operating activities area of the cash flow statement. Cash flow from operating activities includes the sum of net income, changes in working capital and changes for non-cash expenses. Increases of existing assets, including accounts receivables, inventories, and deferred revenue are viewed as uses of cash. Reductions in these types of assets are considered sources of cash. In the same manner, decreases in current financial obligations, including accrued expenses, accounts payable and tax liabilities are considered are considered uses of cash.
  • Reason #3: Another reason they are different has to do with timing. Differences exist between the recognition of revenue and expense and the various underlying cash flows.

Once you understand the difference between net income and cash flow from operating activities, you’ll be on your way to fully comprehending the health of your business. But, what happens when your business is cash strapped? I’ll share strategies in my next post so stay tuned.

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