Question

Discuss and explain the difference between profit/loss and cash flow. How could a company have positive cash flow, but show a net loss at year end? What are some examples of industries and/or companies that might generate substantial cash flow, but could lose money? Conversely, what are some examples of industries and/or companies that might generate very limited cash flow, but could show a profit at year end?

Answer 1

Profit and loss is an analysis of all revenues and income earned by a company for a given period of time and expenses incurred by a company for that period. It should be noted that the revenue could have accrued but not yet received and expenses also could have accrued but not yet paid. In other words profit and loss statement shows revenues and different expenses for a company for a given period irrespective of the fact whether they are paid or not. On the other hand cash flow statement shows the exact amount of a company's cash inflows and outflows during a given period.

A company can have a positive cash flow but show a net loss at year end. Positive cash flow may occur due to several reasons like decline in current assets, increase in current liabilities, sale of fixed assets, raising of capital either through equity or through debt. All these events will ensure a positive cash flow i.e. net increase in cash balance for a period. A company can have a positive cash flow but still show a net loss at year end if the expenses exceed its revenue. Another possible explanation for a company with a positive cash flow but having a net loss at year end is depreciation expense. We know that depreciation expense will have a negative impact on a company’s net income but since it is a non-cash expense it does not entail a cash outflow.

Examples of industries that might generate substantial cash flow, but could lose money are capital goods industries, infrastructure industries, hotel industry etc. All these industries require large scale investments in fixed assets and as such they have substantial amount of depreciation. This causes them to report a net loss, especially in their initial years of operations, while they are still reporting a positive cash flow. Examples of few companies in these industries are GE, Boeing, etc. These companies reported net losses while having positive cash flow during their introduction stage. Conversely industries that might generate very limited cash flow, but could show a profit at year end are those industries which are asset light in structure. Examples of such industries are fintech industry (financial technology), online aggregators industry (as they do not hold any assets of their own), consultancy industry etc.