Question

The operating activities section of the Statement of Cash Flows shows the inflows and outflows from our day to day operations. Why is it that cash flows from operating activities does not equal net income? Is it possible for a company to have net income for the year and have a negative cash flow from operating activities in the same year? Why or why not?

Answer 1

Cash flows from operating activities is a section of a company's cash flow statement that explains the sources and uses of cash from ongoing regular business activities in a given period. This typically includes net income from the income statement, adjustments to net income, and changes in working capital.

Net income is typically the first line item in the operating activities section of the cash flow statement. This value, which measures a business's profitability, is derived directly from the net income shown in the company's income statement for the corresponding period.

The cash flow statement must then reconcile net income to net cash flows by adding back non-cash expenses such as depreciation and amortization. Similar adjustments are made for non-cash expenses or income such as share-based compensation or unrealized gains from foreign currency translation.

The cash flows from the operating activities section also reflect changes in working capital. A positive change in assets from one period to the next is recorded as a cash outflow, while a positive change in liabilities is recorded as a cash inflow. Inventories, accounts receivable, tax assets, accrued revenue, and deferred revenue are common examples of assets for which a change in value will be reflected in cash flow from operating activities.

Accounts payable, tax liabilities, and accrued expenses are common examples of liabilities for which a change in value is reflected in cash flow from operations. Therefore net income does not equal to the cash flow from operating activities.

2)

Yes. Sometimes there will be positive net income and a negative cash flow from operating activities. It is very common.

The operating cash flow is only a subset of the full cash flows of a company. There are also financing and investing cash flows.

Now as for net profit, this is different again. Net profit is revenue less expenses. Most businesses (especially large) operate on an accruals basis. That is, they sell you an item (say a car) but don't actually receive the cash until a future time (say 60 days). On the other hand, they also buy inventory (or goods and services) and do not pay them until a future period as well (say 90 days). What happens is you have a lag between the time you sold the item and the time you received the cash.

So lets take an example of a car keeping in mind that a business has MANY transactions occurring at the same time.

You sell a car for 100k, at the time you sell the car you recognised the revenue of 100k. Now, lets say you bought the car for 60k, this means the net profit is 40k (being 100k-60k).

Lets also say that you have already PAID for the car about 6 months again and haven't received the cash of 100k yet at the end of the period. This means, that you have a cash outflow of 60k or a negative cash flow position of 60k.

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