The difference between net income and net cash flow
/What is Net Income?
Net income is the revenues recognized in a reporting period, less the expenses recognized in the same period. This amount is generally calculated using the accrual basis of accounting, under which expenses are recognized at the same time as the revenues to which they relate. This basis of accounting calls for the use of expense accruals to accelerate the recognition of expenses that have not yet been paid, as well as the use of prepaid expenses to defer the recognition of costs that have not yet been consumed. In addition, sales are recognized as they are earned, rather than when the associated amounts of cash payments from customers are received. The result is a net income figure that does not reflect the amount of cash actually consumed or generated in a period.
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What is Net Cash Flow?
Net cash flow is the net change in the amount of cash that a business generates or loses during a reporting period, and is usually measured as of the end of the last day in a reporting period. Net cash flow is calculated by determining changes in ending cash balances from period to period, and is not impacted by the accrual basis of accounting.
Comparing Net Income and Net Cash Flow
Given these descriptions of net income and net cash flow, the key differences between net income and net cash flow are noted below.
Expense Accrual Differences
Expenses are included in the calculation of net income for which no cash payments may have yet been made. This can be a substantial difference if the cash payments for these expenses are significantly delayed.
Prepaid Expenses Differences
Cash payments for costs incurred may be recorded as assets instead of expenses, since they have not yet been consumed. This tends to be a minor difference, since most organizations do not record significant amounts of prepaid expenses.
Deferred Revenue Differences
Revenues are excluded from the calculation of net income, because they have not yet been earned, even though the related cash may have already been received (perhaps as a customer deposit). This can be a major issue when a company requires its customers to make up-front cash payments, as is common when the goods being sold are customized in nature.
Sales on Credit Differences
Revenues are included in the calculation of net income because they have been earned, even though the related cash receipts may not yet have occurred. This can be a substantial difference when there is a long lag time between when a customer is billed and when payment is received.