Why the net income on the income statement does not equal the change in the cash balance?

Cash flow refers to the net cash generated by the company during the specified period. It is calculated by subtracting the cash outflow’s total value from the cash inflow’s total value. In contrast, net Income refers to the business’s earnings that are earned during the period after considering all the expenses incurred by the company during that period.

Inhaltsverzeichnis Show

• Differences Between Cash Flow and Net Income
• What are Cash Flows?
• What is Net Income?
• Cash Flow from Operations format and example
• Net Income format and example
• Apple Cash flow vs Net Income
• Positive Cash Flows and Postive Net Income Examples
• Snap Inc: Cash flow vs Net Income
• Negative Cash Flows and Negative Net Income Examples
• Pearsons: Cash flow vs Net Income
• Positive Cash flows and Negative Net Income Examples
• Netflix: Cash flow vs Net Income
• Negative Cash Flows and Postive Net Income Examples
• Cash Flow vs. Net Income Video
• Recommended Articles
• Does net income equal change in cash?
• Why profit in income statement does not equal to cash balance at the end of the same period?
• What makes the difference between the net income and the cash position?

Differences Between Cash Flow and Net Income

Amazon’s Net Income is $2.37 billion, and its Cash Flow from Operations is $16.44 billion. Why is there a difference between the two? Cash Flow and Net Income are two key factors in judging whether a company has been doing well or not. But how can we relate to each other?

In this article, we will have a look at both cash flow and net Income to make sense of how they work.

In this article, we will talk about the following –

What are Cash Flows?

The cash flow statement is completely different from the income statement. Let’s take an example to understand this.

A company made revenue of $200 in 2016, and the expenses they have incurred were $110. That means, the net profit is $(200 – 110) = $90.

But from the point of view of the cash flow statement, we need to consider the cash inflow and cash outflow. The company’s cash inflow was $170 (we didn’t collect the whole amount in 2016), and the cash outflow was $90 (the rest of the amount would be paid in 2017). So the net cash inflow is $(170 – 90) = $80.

So it has been proven that even if the company made a profit of $90, its net cash inflow was $80.

And there lies the importance of a cash flow statement. The cash flow statement helps an investor recognize the cash inflow and cash outflow of the company so that they don’t get allured by the hefty profits/ revenue).

It has often been seen that net cash flow is negative for a company even after earning a whopping profit. So, without looking at the cash flow statement, an investor cannot conclude about the performance of a company year by year.

What is Net Income?

Profit or net income is the “bottom line” of the company’s income statement.

To ascertain the profit or net income, a company needs to set up an income statement and determine the net balance of income and expenses.

These income and expenses are reported because the transactions have been done whether or not the cash has been a pair or received.

In the next section below, we will see how to set up a cash flow statement (direct & indirect method both) and income statements to ascertain the net income.

Cash Flow from Operations format and example

First, we will only look at the format of the indirect method of cash flow statements along with an example as it is directly related to the net income. And then, we will look at the format of net income and the example of the same.

Computation of Cash Flow from Operating Activities

• Here lies the importance of net income in the cash flow statement. To start the computation of cash flow from operating activities, you need to start with the net income (we will learn how to find out net income in the next section).
• Then, you need to add back all the non-cash items like depreciation and amortization. We will add them because they are not expensed in cash (only in the record).
• You need to do the same for the sales of assets. If the company has incurred any loss on the sale of assets (which is not a loss in cash), we will add back, and if the company has made any profit on the sale of assets (which is not profit in cash), we will deduct the amount.
• Next, we need to consider any changes that took place during the year regarding non-current assets.Non-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark.read more
• Finally, we will add back or deduct any current liabilityCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.read more and assets. Please note that in current liabilities, we will not include notes payableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. read more and dividends payable in current liabilities.

Now, let’s have a look at the example of the computation of cash flow from the operating activities of Amazon–

source: Amazon SEC Filings

You can see that in the example, we started with the net income and made all the adjustments mentioned above. Non-cash items like DepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more and amortization, stock-based compensationsStock-based compensation also called share-based compensation refers to the rewards given by the company to its employees by way of giving them the equity ownership rights in the company with the motive of aligning the interest of the management, shareholders and the employees of the company.read more are added back. Likewise, changes in operating assets and liabilities like Inventories, accounts receivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more, accounts payablesAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more, etc.

You can learn Cash Flow Statements comprehensively from the following –

• Cash Flow from OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more
• Cash flow from Financing ActivitiesCash flow from financing activities refers to inflow and the outflow of cash from the financing activities like change in capital from securities like equity or preference shares, issuing debt, debentures or repayment of a debt, payment of dividend or interest on securities.read more
• Cash Flow from Investing ActivitiesCash flow from investing activities refer to the money acquired or spent on the purchase or disposal of the fixed assets (both tangible and intangible) for the business purpose. For instance, the purchase of land and joint venture investment is cash outflow, while equipment sale is a cash inflow.read more
• Cash Flow AnalysisCash flow analysis refers to examining or analyzing the company's different cash inflows and outflows during the period under consideration from the various activities, including operating activities, investing activities, and financing activities.read more

Net Income format and example

As you can see, to calculate the net cash flow, we need to refer to the net income (profit). After taking the net income into account, we can add back or deduct the respective adjustments and will ascertain the net cash flow from operating activities under the indirect cash flow method.

So, let’s look at the format and the example so we can understand how to find out the net income in the first place.

Format

Please look at the basic format so we can understand what it is all about in the first place. And then, we will take an example to illustrate it.

Below is the snapshot of the Income Statement of Amazon.

source: Amazon SEC Filings

Now, if, as an investor, you need to set up a cash flow statement under the indirect method, you will be able to start with the net income.

You can also learn about Income Statement from the following comprehensive articles.

• Income StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more
• Income Statement vs Balance SheetIncome statement is one of the financial statements of the company which provides the summary of all the revenues and the expenses over the time period in order to ascertain the profit or loss of the company, whereas, balance sheet is one of the financial statements of the company which presents the shareholders’ equity, liabilities and the assets of the company at a particular point of time.read more
• Profit Margin TypesProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more

Apple Cash flow vs Net Income

Positive Cash Flows and Postive Net Income

See below Apple’s Cash Flow from Operations and Net Income. Both its Net Income and Cash Flows have been positive.

source: ycharts

Which companies have positive cash flows and positive net income?

There can be various reasons that can lead to positive cash flows and net income. Some of these are listed below –

• The company should have Strong Product Lines.
• Should be profitable with strong and consistent Profit Margin
• Writeoffs, Asset Sale, and impairments should be insignificant relative to its Revenue.

Positive Cash Flows and Postive Net Income Examples

Below are some examples of top companies with Positive cash flows and positive net income.

Snap Inc: Cash flow vs Net Income

Negative cash flows vs Negative net income

See below Snap’s Cash Flow from Operations and Net Income. Both its Net Income and Cash Flows are Negative.

source: ycharts

Which companies have Negative cash flows and Negative net income?

• Mostly, these companies do not generate enough revenue compared to their expenses and investments.
• They work on a very thin margin or are loss-making.·      
• Most Tech companies are funded by external private equity investment and go for an IPO who such characteristics.

Negative Cash Flows and Negative Net Income Examples

Below are some examples of top companies with negative cash flows and net income.

Pearsons: Cash flow vs Net Income

Positive Cash Flow and Negative Net Income

Pearsons Net Income is negative. However, its Cash Flow is positive. Why? See below Pearsons Cash Flow from Operations and Net Income.

source: ycharts

The real reason is the Impairment of Intangible Assets. We note that Pearson’s impairment of intangible assets of $2,505 million has led to huge losses in 2016.

source: Persons SEC Filings

Which companies have Postive cash flows and Negative net income?

Some of the companies that may have the above traits are as follows –

• Negative Net income can be because the company is loss-making.
• Mostly, Strong companies report losses due to Bad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation.read more write-offs, impairments, or business restructuring.
• Net Income can be negative also because of Loss on Sale of Assets.

Positive Cash flows and Negative Net Income Examples

Below are some examples of top companies with Postive cash flows and Negative net income.

Netflix: Cash flow vs Net Income

Negative Cash Flows and Postive Net Income

Please See below Netflix Cash Flow from Operations and Net Income. Netflix Net Income is Postive, however, its Cash Flows is Negative. Why?

source: ycharts

Let us have a look at Netflix Cashflow from Operating Activities.

We note that additions to streaming content assets in Netflix is an operating expenseOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more ($8,653 million in 2016) and has led to Negative Cash Flow from Operating Activities.

Negative Cash Flows and Postive Net Income Examples

Below are some examples of top companies with Negative cash flows and Positive net income.

Conclusion

The basic difference between net income and the net cash flow is following –

• First of all, in the case of net income, it doesn’t matter whether the transactions are in cash or not. That means when the net income and revenues are reported on the income statement when they are earned. But in the cash flow statement, we only deal with the cash and cash equivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation.  Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. read more (how much cash comes in and how much cash goes out during a period).
• Second, some expenses considered in the income statement (like depreciation or amortization expenses) are not cash expenses. But still, they are deducted from the revenue. The cash flow statementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more, should be added back to the net income not to affect the cash flow.
•  Third, in the case of net income, even the profits and losses of other sources (consolidated income statement) are considered. But in the cash flow statement, they don’t add or reduce the cash.

Cash Flow vs. Net Income Video

Recommended Articles

This has been a guide to Cash flow vs. Net Income. Here we discuss key differences between cash flow and net income with top examples like Apple, Snap Inc, Netflix, and Pearsons. You may also have a look at the following articles –

• Calculate Net Cash FlowNet cash flow refers to the difference in cash inflows and outflows, generated or lost over the period, from all business activities combined. In simple terms, it is the net impact of the organization's cash inflow and cash outflow for a particular period, say monthly, quarterly, annually, as may be required.read more
• Present Value ExamplePresent Value (PV) is the today's value of money you expect to get from future income. It is computed as the sum of future investment returns discounted at a certain rate of return expectation.read more
• Compare – Operating Income vs Net IncomeOperating income refers to the income earned by a business organization from its principal revenue-generating activities. In contrast, net income refers to earnings after considering all the expenses incurred by the company during a specific period.read more
• What is Net Income Formula?Net Income formula is calculated by deducting direct and indirect expenses from the total revenue of a business.. It is the most important number for the Company, analysts, investors, and shareholders of the Company as it measures the profit earned by the Company over a period of time.read more