So what’s the difference between net income and cash flow from operating activities?
Net income is a company’s profit according to the accrual basis of accounting. Cash flow from operating activities (aka operating cash flow) is a company’s profit after removing the effects of accrual accounting.
Thus, you could view:
• Net income as accrual-basis profit
• Operating cash flow as cash-basis profit
But what does “accrual-basis profit” even mean? It means that net income increases when revenues are earned and decreases when expenses are incurred, not necessarily when cash changes hands. In other words, cash coming in or out has no effect on net income.
To find the cash generated by the company’s operations, you don’t go to the income statement. You go to the statement of cash flows.
There are 3 sections in the statement of cash flows (operating, investing, financing) but the information you want is in the top section: operating activities.
Now the operating activities section will be presented in one of two ways:
• If the company uses the direct method, it will show cash collected from customers and then subtract cash payments to suppliers, to employees, and for interest and taxes.
• Now if the company uses the indirect method, the operating section will instead start with net income and show various adjustments to undo the effects of accrual accounting
So how are net income and operating cash flow related?
net income = revenue recognized – expenses incurred
net income + / - adjustments = operating cash flow
How is operating cash flow derived from net income?
Can a company have net income and negative cash flows?
So which is better: net income or operating cash flow?
• You’ll hear more about net income in the financial news because it’s the basis for calculating earnings per share
• And analysts pay a lot of attention to earnings
• So it’s tempting to overlook operating cash flow
But remember that net income, and thus earnings per share, is the result of accruals. And accruals are affected by managers’ judgement, estimates, and in some cases manipulation.
Thus, it’s best to evaluate a company’s net income and its operating cash flow, and to make sure you understand any discrepancies between the two
0:00 Introduction
0:23 What is accrual-basis profit?
1:10 Two ways to present operating activities
1:53 How are net income and operating cash flow related?
2:10 How is operating cash flow derived from net income?
3:13 Can a company have net income and negative cash flows?
5:15 Which is better: net income or operating cash flow?
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