Sunday 26 October 2014

How a Company Can Have a Negative Net Income and a Positive Cash Flow?

The situation seems to be a bit counter-intuitive but it is very common and is not that difficult to comprehend. Breaking down the factors at play for examining more closely will help you to understand better how it is possible for a company to have appositive cash flow but a negative net income.

When people talk about net income, they talk about the number, which has been computed by their accountants and reported on the income statement of the company. In a simple way, it can be said that the annual net income of a company is its revenue minus all the applicable expenditures in the given year. When the company’s expenses become greater than the revenue that it has earned, it incurs a loss for that given year, which needs to be reported on the income statement.
Let us have a closer look at the various kinds of expenses a firm can incur. The income statement may include expenditures like depreciation, usage of prepaid expenses, losses recorded on the paper for bad debt expenses. These kinds of expenditures are not the type of expenses the firm actually pays cash for.

Now let us say that a company in Auckland had a net loss of $200,000 for a given year. It recorded about $200,000 in depreciation for that year and used up about $100,000 of the prepaid expenses and wrote $150,000 of the bad debts it knew it will never be able to collect. The cash flow for that year is then $450,000, which is more than the net income that’s reported on the income statement by their tax accountant in Auckland. This means the cash flow is positive but it is not going to pay any income tax for that year because it has recorded a net loss. However, in reality the company has more cash on hand than it had at the beginning of the year.

Before investing in bonds or stock of a company, investors must be aware of the cash flow and the net income of the entity. What good is it going to be for a shareholder if the company has got a cash flow that’s positive but is hit with net losses repeatedly?


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