Net income and free cash flow are related but are not the same measure. Net income represents a company's accounting profit, whereas cash flow presents whether a company's cash balance increased or decreased. Learn more about the definitions and differences of these 2 measures.
Cash Flow & Free Cash Flow Definitions
Put simply, cash flow reflects money coming into and going out of a business. Cash Flow from Operations (or CFO) reflects the cash flow attributed strictly to a company's business operations. Free cash flow represents what's remaining from CFO after expenses necessary to maintain the equipment and operations of the company.
Definitions of cash flow and free cash flow are:
Cash flow in a business refers to the amount of cash coming in and out of a company during a specific point in time. Positive cash flow means that more money is coming in than going out, while negative cash flow means the business is spending more than it's receiving.
Cash Flow from Operations (CFO), or sometimes referred to as Operating Cash Flow, reflects only the cashflows directly related to a company's business operations.
Free Cash Flow (FCF), is the amount of operating cash flow remaining remaining after a business pays for necessary upkeep of its equipment and operations. Investors commonly look at FCF to assess the cash flow strength of a company. Free Cash Flow reflects cash that a business can use to invest in growth or other value maximizing purposes.
Net Income Definition
Net income is an accounting measure that reflects the difference between the amount of revenue that a company earns and total expenses for the same period. If total expenses exceed revenue, this company has realized a net loss. To calculate net income, total expenses are subtracted from total revenue. Often referred to as "the bottom line," net income is reported by public companies on both quarterly and annual income statements.
Cash Flow vs. Net Income
Cash flow and net income share some similarities but they are different items with unique calculations and purposes. The cash flow statement and the income statement are completely different financial statements.
Cash Flow:
Refers to the net amount of cash generated by a company over a specific period of time.
Calculated by subtracting total cash outflow from total cash inflow.
Cash flows are typically fully objective measures, and not impacted by decisions surrounding accounting methods.
Cash flow may also be more volatile than net income.
Net Income:
Net Income is an accounting construct, and refers to company earnings for a given period, which reflects accounting revenues less accounting expenses.
Net income reports how much of a profit a company generated after paying all of its expenses. This profit can then be presented on a per share basis (Earnings Per Share).
Management teams often have some leeway in revenue recognition and the categorization and calculation of some expenses.
Net Income can be misleading because positive net income doesn't always reflect the reality of the business. Cash flow analysis is sometimes a better metric for assessing a company's financial health.
Free Cash Flow vs. Net Income
Free cash flow and net income are not the same.
Free Cash Flow:
Must be manually calculated by finding cash flow from operating activities on a company's cash flow statement, then subtracting out capital expenditures for maintenance purposes.
When positive, FCF indicates a company's potential for investing in growth or paying dividends to shareholders.
FCF be more effective than net income for measuring a company's financial health.
Net Income:
Can be easily found by looking at "the bottom line" of a company's income statement.
Is commonly reported on a per share basis as EPS.
When positive, net income indicates that a company's accounting revenue exceeds its accounting expenses. If accounting expenses exceed accounting revenue, the company will have incurred a net loss for the period.
When to Use Net Income vs. Free Cash Flow
Net income is a good starting point for determining the profitability of a company but free cash flow is often a focal point for determining if a company is a good investment. Cash flow measures may also detect business problems like growing inventory balances, or troubles with collecting Accounts Receivable.
Bottom Line
Net income and cash flow have similarities but they do not share the same meaning or purpose. For example, net income reflects a company's accounting profit but free cash flow can be a better indicators of the true economic value a company is creating.
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Net Income is the result of revenues minus the expenses, taxes, and costs of goods sold (COGS). Operating cash flow
Operating cash flow
Operating cash flow (OCF) is a measure of the amount of cash generated by a company's normal business operations. Operating cash flow indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations, otherwise, it may require external financing for capital expansion.
is the cash generated from operations, or revenues, less operating expenses. Many investors and analysts prefer using operating cash flow as an indicator of a company's health.
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 from operating activities.
Revenue is the money a business earns by selling its services and products, and cash flow is the net total of money transferred out and into the company. While revenue indicates the value of a company's marketing and sales, cash flow indicates the cash available to the business.
Net operating income is a measure of profitability in real estate—the amount of cash flow a property generates after expenses. Operating cash flow is the money a business generates from its core operations. Net operating income is generally the same as operating income for a company.
Key Takeaways. Revenue is the money a company earns from the sale of its products and services. Cash flow is the net amount of cash being transferred into and out of a company. Revenue provides a measure of the effectiveness of a company's sales and marketing, whereas cash flow is more of a liquidity indicator.
Key Takeaways. Net Income is the result of revenues minus the expenses, taxes, and costs of goods sold (COGS). Operating cash flow is the cash generated from operations, or revenues, less operating expenses.
The cash flow statement must then reconcile net income to net cash flows. This is done by adding back non-cash expenses like depreciation and amortization. Similar adjustments are made for non-cash expenses or income such as share-based compensation or unrealized gains from foreign currency translation.
A business could make net profit while having negative cash flow. Earning revenue does not necessarily mean that the company has received cash immediately. The actual movement of cash may happen later. For instance, a company sold goods and accrued profit on the income statement but did not receive the money yet.
Because it measures cash remaining at the end of a stated period, it can be a much "lumpier" metric than net income. For example, if a company purchases new property, FCF could be negative while net income remains positive. Likewise, FCF can remain positive while net income is far less or even negative.
Cash flow statements are a good barometer of whether your debt levels are sustainable and whether your cost of debt is manageable or not based on your sustainable operating cash flows. Remember, you need real cash to pay your debts and book profits are not sufficient.
A cash flow statement shows the exact amount of a company's cash inflows and outflows over a period of time. The income statement is the most common financial statement and shows a company's revenues and total expenses, including noncash accounting, such as depreciation over a period of time.
In addition, a company's revenue recognition principle and matching of expenses to the timing of revenues can result in a material difference between OCF and net income. Unfortunately, it is not possible to simply say that one number is always higher or lower than the other.
Namely, your net income represents the profitability of your business, while the cash flow will reveal how much cash you actually have on hand at a given time.
A higher ratio can also mean more investors and better credit terms from financial institutions. In general terms, an operating cash flow to sales ratio of 10% to 55% is considered good, with a higher number indicating a better ability to convert sales directly into cash.
While profit will show you the immediate success of your business, cash flow may be a more astute means of determining your company's long-term financial outlook. In this sense, the key difference between the two metrics is time.
The cash flow statement follows the cash basis of accounting that works on the actual payments and receipts of cash. The income statement follows the accrual basis of accounting that works on the basis of income/payments that are either due or received in advance.
The main difference between accounting income and cash flow is that accounting income is a measure of profitability, while cash flow is a measure of liquidity. Accounting income includes non-cash items such as depreciation, which reduces taxable income but does not affect cash flow.
The difference between net income and net cash flow from operating activities exists because the shop is not selling all the inventory that it purchased during the period.
Or, if a company made a large purchase (like buying a new property or investing in new intangible assets) in the recent past, then free cash flow could be higher than net income -- or still positive even when a company reports a net loss.
Introduction: My name is Fr. Dewey Fisher, I am a powerful, open, faithful, combative, spotless, faithful, fair person who loves writing and wants to share my knowledge and understanding with you.
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