How is free cash flow or operating cash flow different from net income and profit?

Whether you’ve taken accounting or not, you’re probably already familiar with the concepts of income and “profit.” Income is how much you earn and it goes directly into your pocket, whether it’s from a salary, a business, or both. On the other hand, simply put, profit is more specific in the sense of how much you make from a business…it’s your sales minus your costs and expenses. This is why earnings are sometimes called “net” income.

However, you should be careful when using the term profit or net income. It means you win, but it doesn’t necessarily mean you win real money. Why? Let’s say you sell someone a watch. Pick up the watch from your store and promise to pay you $100 cash after 1 month. Do you record in your books that the sale occurred today or a month later? Surprise surprise! Based on generally accepted accounting principles (GAAP), you must record that the sale was made today. Not next month. So you can also record your winnings today…even if you haven’t won real cash yet. This type of benefit is called “earned” income. You earn income even without collecting any cash yet.

This is where the difference between a Net Income Statement and a Free Cash Flow Statement comes in. A Statement of Net Income shows net income, based on cash receipts and increased income, as well as cash expenses and increased expenses. A free cash flow statement shows free cash flow based on all the actual cash the business earns, minus all the cash payments the business actually makes. A free cash flow statement does not take into account accrued income and does not take into account accrued expenses that have not yet been paid in cash.

Also, a Statement of Net Income does not reflect cash payments for capital (such as the business building, property, and equipment), but the Statement of Free Cash Flow reflects these payments as long as these payments have (already) been made. made in cash.

It can be said that the Net Income Statement and the Free Cash Flow Statement represent 2 different philosophies. So who follows what philosophy? Basically, accountants prefer to use the income statement to report the profit of the company. The government also usually looks at your income statement when it wants to figure out how much tax you have to pay. On the other hand, modern financial managers generally prefer to view the free cash flow statement as a true measure of “how well the company is doing”, believing that revenue isn’t really revenue unless you actually earn cash.

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