Question

In: Accounting

“There is a growing discrepancy between the company’s Cash Flow from Operating Activities and its reported...

There is a growing discrepancy between the company’s Cash Flow from Operating Activities and its reported Net Income. Summed over the last three years, total Net Income is about $10 billion while the total Cash Flow from Operations is double this amount, about $20 million! The company must be overstating its expenses and reserves/allowances.

After reviewing Starbucks' 2018 10K, comment on this statement. What are the main reasons for the above-mentioned discrepancy? Do you agree that the discrepancy represents a buildup of reserves? In general, should we expect Net Income and Cash Flow from Operations Activities to converge to a very similar cumulative number in the long run (that is, the discrepancy between the two would become small)?

Solutions

Expert Solution

The basic reason that differentiates Cash flow from Operating activities from Net Income is that the Income Statement contains notional expenses as well whereas Cash Flow from Operating activities constitutes actual cash spends in relation to the Principal business of the company.

Operating Cash flow is the revenue from Operations less operating expenses.

Net Income is the result of Revenues less expenses, taxes and Cost of Goods sold.

Operating cash flow handles the day-to-day activities of the company where as Net Income statement is arrived at post allocation towards notional expenses like Amortisation, Depreciation etc. Its is highly probable that the could be a negative Income despite having a positive Operating cash flow. This could be due to allocation of profits towards Reserves.

To conclude, if a company wants to assess its capability of continuing its operations, Operating Cash flow statement is to be examined. Whereas, if a company wants to figure out the actual Income available for Dividend distribution, Income statement is to be relied upon.


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