Question

Differentiate between net cash flow and accounting profit. A firm has net income of $5 million. Assuming that depreciation of $1 million is its only noncash expense, what is the firm’s net cash flow?

Answer 1

Part 1:
Accounting profit refers to the net profit as calculated in income statement. It does not show how much cash a company generates. However, net cash flow is calculated as:
Cash flows from operating activities+Cash flows from investing activities+Cash flows from financing activities

In cash flow from operations non cash charges are added to net income, increase in accounts receivables is subtracted, increase in accounts payable is added etc.

Example for accounting profit: If the sales revenue is $1000 and accounts receivables is say $900, then the $900 will not be recorded for accounting profit because in income statement we do not record accounts receivables.

Example for net cash flow:
If net income is say $1000 and accounts receivables is $900 then while calculating cash flows, we need to subtract $900 from net income and the cash flow will be $1000-900=$100

Part 2:
Net income=$5 million
Depreciation=$1 million

Net cash flow=$5+$1=$6 million

Note: Non cash charges are added because they are actually not cash expenses but we need to subtract depreciation from earnings before interest, tax,depreciation and amortization (EBITDA) while calculating net profit.