Question

Consider the dilemma you might someday face if you are the chief financial officer of a company that is struggling to maintain a positive cash flow, despite the fact that the company is reporting a substantial positive net income. Maybe the problem is so severe that there is often insufficient cash to pay ordinary business expenses, like utilities, salaries, and payments to suppliers.

Required:  Discuss the paradox of this situation.How can a company have a positive net income, but is not able to pay ordinary business expenses?

Answer 1

Answer

Net Income = Income (-) Expense.

Under Accrual Method of Accounting, Company can record Income earlier of Cash Received or Earned that is after Completing Performance Obligation in form of Delivery of Goods or Performing the Services.

Due to Accrual Method, at times Company has Positive Net Income as Earned Income which is not received in Cash is also Included in Calculating Net Income but Actually Cash Is not received by Company. inclusion of earned income may result into Positive Net Income but Situation of Cash will not be altered or increased.

Another reason of Positive Net Income but insufficient cash to Pay Ordinary Expenses is due to deferring the High Amount Expenses that is Process of Recording High Amount Expenses over more than one year. (multiple years). Such deferred Expense will reduce Overall expenses and may result into Positive Net Income.

Thus, Based on above arguments, One can conclude that even though Company has Positive Net Income but not able to pay ordinary business expenses.