Real Estate

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

Whether you’ve taken up accounting or not, you probably already know the concepts of income and “earnings.” Income is the amount you earn that goes directly into your pocket, whether it’s from a salary, a business, or both. On the other hand, generally speaking, profit is more specific as to how much you earn from a business … it’s your sales minus your costs and expenses. This is why earnings are sometimes referred to as “net” income.

However, you must 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! Under generally accepted accounting principles (GAAP), you must record that the sale was made today. Not next month. So you can also reserve your winnings today … even if you haven’t won any cash yet. This type of benefit is called “increased” income. You get income even without collecting cash yet.

This is where the difference between a statement of net income and a statement of free cash flow comes into play. A statement of net income shows net income, based on cash income 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 the increase in income and does not take into account the increase in expenses that have not yet been paid in cash.

Also, a statement of net income does not reflect cash payments for capital (such as business building, property, and equipment), but the statement of free cash flow does reflect these payments as long as these payments have been made (already ) in the form of cash.

It can be said that the statement of net income and the statement of free cash flow represent 2 different philosophies. So who follows which philosophy? Basically, accountants prefer to use the income statement to report the company’s earnings. The government usually also looks at your income statement when it wants to calculate the amount of taxes you must 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 business is doing,” believing that income is not really income unless you actually make cash.

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