In: Accounting
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?
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.