How can it be possible for a company to have a positive cash flow from operations in the same year as it has a net loss or to have a negative cash flow in the same year that it has a net income?

Answer 1

Well very simply...cash is generated from sales and many other things (whether they make a profit or not). But generally, expenses that use cash are incurred at some other time. Also, frequently cash can become something else...say a company uses cash to buy a building, or inventory...it still is worth just as much as before...just the asset of cash is now an asset of some type of property. No profit or loss was made...(maybe later on sale of the property)...but cash was reduced.

For instance, "depreciation" is subtracted from net income, but doesn't actually cost you any money. To answer both questions, say a company sells 100 dollars worth of product that cost 50 dollars to make. The net cash flow is 50 dollars. Now say they had to buy a new capital machine that cost 100 dollars, their net income would still be 50 even though their cash flow was -50. This is because capital expenditures are not "expensed" immediately but are "depreciated". So the next year under the same scenario with no capital expense if you show 50 dollars of depreciation you would have no net income but positive cash flow.

Not only is depreciation a factor, but almost everything that takes place in the business. You can sell something today (increasing income) but not collect the cash until later. Thus, income is increased, but cash not until later. Similarly, you can buy something, deduct it from income, but not pay for it until later. The timing of real cash receipts and real cash disbursements is different from the timing of the transaction. It is the actual sale or purchase than can affect income, but only the actual collection or payment of cash will affect "cash flow," i.e. the flowing of cash into and out of the business.

The above does a good job of describing some of the reasons. Some others related to those to are - most business need to use accrual method of accounting, not cash method. However, even those that may use the cash method can have what you inquire about. The use or generation of cash is entirely different than the making of a profit.

For example, in one year you may expend a lot of cash to buy an investment...whether you make a profit that year or not is dependent on all the other operations of the company....(and for conceptual purposes, say all of them are already paid for). The some years later, same biz, investment Co with everything paid for, no revenues or dividends coming from the investments - they are all just "raw land" or something. Therefore, under cash method, this year they sell something. Positive cash flow. Did they make a profit? Well that all depends on if what they sold they paid more (or less) for than they sold it for!

Cash flow and profit are comparing raw apples and well cooked green beans.

To correct the original post, depreciation isn't subtracted from net income. Depreciation, along with the other expenses of doing business, is subtracted from revenues to arrive at net income.

An example of how a company could have positive cash flow from operations in the same year as it has a net loss:

• Frank's Wholesale Felines sells 1000 pure-bred kitties to pet shops at $500 each during 2007 for revenues of $500,000. Frank paid $200 for each of the kitties to the breeders and incurred a further $100,000 in related expenses (wages, rent, kitty litter, etc).
• To make the example simple, assume that all transactions are cash
• Frank's business would therefore (in simplified terms!) show positive cash flow from operations of $200,000.
• However, around Christmas time some Animal Rights Activists freed 500 kitties (worth $100,000) and torched Frank's warehouse (book value of $750,000).
• Assuming this isn't a common occurence, it wouldn't be considered a business expense. Therefore, it wouldn't affect the cash flow from operations.
• This would probably qualify as an 'extraordinary item' on the income statement, which is a loss that appears further down from the operations info, net of tax implications.

It might also be helpful to discuss the difference between accounting income, which is accrual based, and cash flow.

According to Canadian GAAP, revenue must be recognized (ie, presented in an income statement) when performance is achieved, measurability is reasonably assured, and collectibility is reasonably assured.

Notice that revenue is recognized when collectibility is reasonably assured - not when money is actually collected.

A simple example:

• Alex & Co. is a new web design company. In order to attract business, customers spending more than $10,000 don't have to pay for 1 year.
• Once the work is done, and assuming collectibility is reasonably assured (and it would have to be - otherwise they wouldn't do the deal, right?) the revenue should be recognized, even though they won't actually get paid for a year.
• Meanwhile, Alex still has to pay his rent, his wages, etc.
• Voila, negative cash flow, positive income (assuming revenues exceed expenses, of course)