Cash Flow vs. Net Income: 6 Fundamental Differences

By Indeed Editorial Team

Published April 29, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Businesses and individuals may benefit from understanding accounting concepts to assess their financial situation and make decisions. For example, it's important for companies to recognize the differences between their cash flow and their net income and understand what these values mean for their business. Understanding how to evaluate these financial terms and the information they present about a business can help accountants and organizational leaders analyze the success of the company and make changes to their financial procedures if necessary.

In this article, we review what cash flow is, define what net income is and provide a list of the primary differences between these two terms.

What is cash flow?

Cash flow is the outbound and inbound movement of money an organization experiences because of expenses, sales and contributions from shareholders. A company may review its cash flow to gain a better understanding of its current financial situation and make important business decisions. Since cash flow data shows an organization where its money comes from and where it's spent, professionals may consider cash flow to be the same as a company's checkbook. Maintaining a positive cash flow allows companies to pay for expenses that arise without overdrawing their accounts or acquiring debt.

The formula for calculating cash flow is:

**Cash flow = Operating activities + investing activities + financing activities**

Related: Understanding Cash Flow Statements: A Complete Guide With Steps, Methods and Examples

What is net income?

Net income is the value of a business' revenue after subtracting all the company's expenses. This means the net income is equivalent to an organization's profit, and represents the amount of money it made within a specific fiscal period. When calculating net income, businesses subtract expenses such as depreciation, taxes, the cost of undertaking the business, interest and employee salaries. Net income is a value companies list in their cash flow statements because it involves subtracting the outbound cash flow, which are expenses from the inbound cash flow, which is revenue.

Companies can use this formula to calculate their net income:

Net Income = Total revenue – total expenses

Related: How To Calculate Net Income: Formula Plus Examples

6 differences between cash flow and net income

In the cash method of accounting, a business' cash flow and net income are equivalent. However, in the accrual method of accounting, these two concepts differ significantly. Since there are gaps in time between the sale of an item and payment, differences occur between net income and cash flow because the accrual concept of accounting requires a company or individual to track all accrued income and account for all incurred expenses. Understanding the differences between these two figures allow investors to determine whether investing in a company is a good idea, or if the situation is too risky.

Here's a list of the fundamental differences between cash flow and net income, and how these two financial concepts can affect a business or impact the decisions made by investors and other stakeholders:

1. Highlighting profitability

If a stakeholder or potential investor is interested in learning about a company's profitability, they may want to review its net income. Since this value considers the overall revenue and the funds that remain after accounting for business expenses, it allows professionals to gain an understanding of the profit an organization can yield. Instead, cash flow reveals an organization's working capital and its cash position and solvency.

Related: How To Create a Cash Flow Projection

2. Evaluating value and risk

Companies can use cash flow statements to review the value of the organization, particularly regarding its liquidity and the ability to convert to cash when required. Investors may also review a business' cash flow statement to review and analyze risk and gain a better understanding of business expenses versus revenue and sales. While a growing organization may have a low net income as owners make investments and acquire expenses related to expansion, a cash flow statement allows stakeholders to gain a deeper understanding of the business's earning potential and the amount of revenue it currently produces.

Related: Guide to Cash Flow

3. Manipulating under the GAAP

The generally accepted accounting principles (GAAP) are corporate accounting guidelines businesses follow that include the specificities and complexities of business-related accounting. Professionals may have a difficult time manipulating cash flow under the GAAP since cash flow requires organizations to calculate its value with physical cash and bank funds. Alternatively, net income is easier to manipulate, and companies can do this by increasing revenues or decreasing business costs. Since it's harder to manipulate, cash flow is typically a better metric with which to gauge a company's financial health.

4. Dividing into different categories

One primary difference between cash flow and net income is the number of categories they contain. Companies usually divide cash flow into three main categories: financing activities, operating activities and investing activities. This allows organizations to gain an overview of all the funds that enter and leave their business. Instead, organizations place their net income into two primary categories: operating activities and non-operating activities, both of which encompass cash and non-cash transactions.

Related: Operating Income, Net Income and Net Operating Income: Definitions

5. Gathering information to prepare statements

Individuals can calculate cash flow and prepare cash flow statements with the use of an income statement and a balance sheet. This allows them to consider all sales and costs to make an accurate analysis of the movement of funds in and out of a company's account. Alternatively, organizations review books of accounting ledgers to understand and evaluate their profit and net income.

6. Including various components

When companies assess their current cash flow, they only evaluate cash items and don't take other forms of revenue into consideration. However, when they're calculating the net profit, organizations consider all revenue and expenses, including both cash and non-cash items. This means that calculating cash flow involves cash accounting, whereas determining the net income requires accrual accounting.

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