How Do Net Income and Operating Cash Flow Differ? (2024)

Net income is the profit a company has earned for a period, while cash flow from operating activities measures, in part, the cash going in and out during a company's day-to-day operations.Net income is the starting point in calculating cash flow fromoperating activities. However, both are important in determining the financial health of a company.

Net Income

Net income is calculated by subtracting the cost of sales, operational expenses, depreciation, interest, amortization, and taxes from total revenue. Also called accounting profit, net income is included in the income statement along with all revenues and expenses.

Below is the income statement for Exxon Mobil Corporation (XOM) from the company's 2017 10-K statement:

• Revenue or totalsales= $237billion (blue).
• Total costs and other deductions= $225.68billion (in red).Total costsincludemanufacturing expenses of $34 billion, expenses of $10.9 billion,and$19.893 billion in depreciation costs spread out over years for the purchaseof assets like property, plant, and equipment.
• Profit or net income= $19.8 billion (green) after subtracting costs, deductions, and taxes.

Cash Flow From Operations

Cash flow from operationsis part of the statement of cash flows. Thecash flow statementis a financial statement that summarizes the amount ofcash and cash equivalentsentering and leaving a company.

The cash flow statement (CFS)measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses.

Cash flow from operations includes day-to-day,core activities within a business that generate cash inflows and outflows. They include:

• Receipts from sales of goods and services,collected during a period
• Payments made to suppliers of goods and services used in production
• Payments to employees or otherexpensesmade during a period
• Rent payments
• Income tax payments

Cash flow from operating activitiesalso reflects changes to certain current assets and liabilities from the balance sheet. Increases incurrent assets, such as inventories, accounts receivable,and deferred revenue, are considered uses of cash, while reductions in these assets are sources of cash. Similarly, decreases in current liabilities, such as accounts payable, tax liabilities, and accrued expenses, are considered uses of cash (cash outflowto pay off debt), while increases in these liabilities are sources of cash (cash inflow from the new borrowed capital).

Cash flow from operating activities excludes theuse of cash for purchases ofcapital expendituresandlong-term investments, as well as any cash inflows from the sale oflong-term assets. Cash paid out as dividends to stockholders and cash received from a bond andstockissuance are also excluded.

Cash FlowFrom Operationsvs.Net Income

Net incomeis carried over from the income statement and isthe first item of the cash flow statement.Net cash flow from operating activities is calculated as the sum of net income, adjustments for non-cash expenses, and changes in working capital.

However, certain items are treated differently on the cash flow statement than on the income statement. Non-cash expenses,such as depreciation, amortization, and share-based compensation,must be included in net income,but thosecosts do not reduce the amount of cash a company generates in a given period. As a result, these expenses are added back into the cash flow statement.

Below is the cash flowstatement for Exxon Mobil Corporation from the 2017 10K statement:

• The net income figure of $19.8 billion (green) is the top line of the cash flow statement.
• The depreciation amount of $19.8 billion (blue) wasadded back into cash flow. If you recall earlier, it was a deduction on the income statement.
• Net cash from operations was $30 billion (red) for the year for Exxon.

Cash Flow Increase FromOperating Activities

Companies can increase cash flow from operations by improving the efficiency with which they manage their current assets and liabilities.Rising inventory turnover indicates improving inventory management since it shows low inventory relative to sales and, as a result, becomes a source of cash.

• Improved account receivable collection practices drive down days sales outstanding, decreasing accounts receivable. If accounts receivable decreases, this implies that more cash has entered the company from customers paying off their credit accounts—the amount by which AR has decreased is then added to net sales. If accounts receivable increases from one accounting period to the next, the amount of the increase must be deducted from net sales because, although the amount represented in AR is revenue, it is not cash. In short, lower days sales outstanding indicates that a company is collecting receivables more quickly, which is a source of cash.
• Growing days payable outstanding is considered a positive development, from a cash standpoint, assuming the company is not incurring borrowing costs or straining supplier relationships. As days payable outstanding grows, cash flows from operations increases.

The Bottom Line

Financial statements, like the income statement and cash flow statement,provide an ongoing record of a company's financial condition and are used by creditors, market analysts, and investors to evaluate a company's financial soundness and growth potential.Both net income and cashflowshould be compared with other companiesin the industry to obtain performance benchmarks and to understand any potential market-wide trends.