Question

In: Accounting

​​​​​​When a company has positive net income, does that also mean they have positive cash flows?...

​​​​​​When a company has positive net income, does that also mean they have positive cash flows? What is more important to a company - positive cash flow or net income? Is this true for both the long term and short term?

Solutions

Expert Solution

A company has positive net income this does not mean that it must also have positive cash flows. This happens because of the Non cash items charged and in income statement. For example, a company may receive cash in advance for a goods or service to be delivered in future , this transaction shall increase cash flows but not the income. On the other hand, sales on credit will increase income but not the cash flows.
Sometimes, it does happen that the company is in profit but is in cash crunch unable to pay dividends and creditor payments.
Thus it can be clearly said that if a company has positive net income, it is not necessary for it to have positive cash flows.

Illustrative example of the same can be given as follows:
Income statement
Credit sales    -----    25,00,000   
Expenses (Including O/s of 200000)---- 12,00,000
Income--------------- 13,00,000

Cash flows statement
Receipt from the debtors---------    NIl
Expenses    10,00,000
Cash flow    (10,00,000) Negative

Thus, it can be said that inspite of having positive income, cash flows are negative.

It is important for the company to have positive income in the long term, also at the same time maintaining cash balances to meet the liquidity requirement. If a company have negative income long term, eventually entity would be facing negative cash flows unless debt is infused in operating the entity.

In the short run entities would be attracted towards more cash inflows for expansionary purposes and for the lower cost of capital. In the short run it may be good for the company to earn greater cash flows. But at the same time entity should earn enough income to maintain networth and trust of the shareholders. If company wants to repay a debt falling due, its focus in the short run would be on greater cash flows and sacrifice in Income.



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