A:

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. However, both are important in determining the financial health of a company.

Net Income

Net income is calculated by subtracting cost of sales, operational expenses, depreciation, amortization, interest, and taxes from total revenue. Also called accounting profit, net income is included on the income statement along with all revenues and expenses.

Below is the income statement for Exxon Mobil Corporation (XOM) from the company's 2017 10K statement

  • Revenue or Total Sales = $237 billion (highlighted in blue).
  • Total costs and other deductions = $225.68 billion (in red). Total costs include manufacturing expenses of $34 billion, SG&A expenses of $10.9 billion and $19.893 billion in depreciation costs spread-out over years for the purchase of assets like property, plant, & equipment.
  • Profit or Net income = $19.8 billion (green) after subtracting costs, deductions, and taxes. 

Cash Flow From Operations

Cash flow from operations is part of the statement of cash flows. The cash flow statement is a financial statement that summarizes the amount of cash and cash equivalents entering and leaving a company. 

The cash flow statement (CFS) measures how well a company manages its cash position, meaning how well the company generates cash to pay it's debt obligations and fund it's operating expenses.

Cash flow from operations includes day-to-day, core activities within a business that generate cash inflows and outflows. They include the following:

  • Receipts from sales of goods and services, collected during a period
  • Payments made to suppliers of goods and services used in production
  • Payments to employees or other expenses made during a period
  • Rent payments
  • Income tax payments

Cash flow from operating activities also reflects changes to certain current assets and liabilities from the balance sheet. Increases in current assets such as inventories, accounts receivable, and deferred revenue are considered uses of cash, while reductions in these assets are sources of cash. Similarly, decreases in current liabilities such as accounts payable, tax liabilities and accrued expenses are considered uses of cash (cash outflow to pay off debt), while increases in these liabilities are sources of cash (cash inflow from the new borrowed capital).

Cash flow from operating activities excludes the use of cash for purchases of capital expenditures and long-term investments, as well as any cash inflows from the sale of long-term assets. Cash paid out as dividends to stockholders, and cash received from bond and stock issuance are also excluded.

How Cash Flow From Operations Differs From Net income

Net income is carried over from the income statement and is the first item of the cash flow statement. Net cash flow from operating activities is calculated as the sum of net income, adjustments for noncash expenses and changes in working capital.

However, certain items are treated differently on the cash flow statement than on the income statement. Noncash expenses such as depreciation, amortization, and share-based compensation must be included in net income, but those costs do not reduce the amount of cash a company generates in a given period. As a result, these expenses are added back into the cash flow statement.

Below is the cash flow statement for Exxon Mobil Corporation (XOM) from the company's 2017 10K statement

  • The net income figure of $19.8 billion is the top line of the cash flow statement.
  • The depreciation amount of $19.8 billion (in blue) was added back into cash flow. If you recall earlier, it was a deduction on the income statement.
  • Net cash from operations was $30 billion for the year for Exxon.

Factors That Can Increase Cash Flow From Operating Activities

Companies can increase cash flow from operations by improving the efficiency at which they manage their current assets and liabilities. Rising inventory turnover indicates improving inventory management since it shows low inventory relative to sales and as a result, becomes a source of cash. 

Improved account receivable collection practices drive down days sales outstanding, decreasing accounts receivable. If accounts receivable decreases, this implies that more cash has entered the company from customers paying off their credit accounts – the amount by which AR has decreased is then added to net sales. If accounts receivable increases from one accounting period to the next, the amount of the increase must be deducted from net sales because, although the amounts represented in AR are revenue, they are not cash. In short, lower days sales outstanding indicates that a company is collecting receivables more quickly, which is a source of cash.

Growing days payable outstanding is considered a positive development, from a cash standpoint, assuming the company is not incurring borrowing costs or straining supplier relationships. As days payable outstanding grows, cash flows from operations increases.

Takeaways

Financial statements like the income statement and cash flow statement provide an ongoing record of a company's financial condition and are used by creditors, market analysts, and investors to evaluate a company's financial soundness and growth potential. 

Net income is a key metric of profitability and is a major driver of stock prices and bond valuations. The cash flow from operating activities section demonstrates the adjustments made to net income.

Unlike net income, operating cash flow excludes non-cash items like depreciation and amortization, which can misrepresent a company's actual financial position. A company with strong operating cash flows has more cash coming in than going out. And companies with strong growth rates or improving cash flows are more likely to have stable net income, be able to increase dividends, expand operations, and weather economic downturns.

Both net income and cash flow should be compared with other companies in the industry to obtain performance benchmarks and to understand any potential market-wide trends.

For more articles on the cash flow statement and net income, please read "What Is A Cash Flow Statement?" "What's the Formula for Calculating Free Cash Flow?" "Reviewing the Cash Flow From Operations," and "What's the Difference Between the Income Statement and Balance Sheet?"

RELATED FAQS
  1. What are some examples of cash flow from operating activities?

    Learn about cash flow statement and cash flows from operating activities. Understand how these examples differentiate investing, ... Read Answer >>
  2. What is the difference between operating cash flow and net income?

    Learn how net income is an income statement for a certain period of time, while cash flow shows inflows and outflows based ... Read Answer >>
  3. Are taxes calculated in operating cash flow?

    Learn how taxes are involved with the calculations for a firm's operating cash flow, and the overall significance of operational ... Read Answer >>
  4. What factors decrease cash flow from operating activities?

    Understand the types of factors that reduce cash flow from operation activities. Discover how declining net income and efficiency ... Read Answer >>
  5. What is the difference between Operating Cash Flow and Net Operating Income (NOI)?

    Learn what operating cash flow and net operating income are, how the two metrics are calculated and the main difference between ... Read Answer >>
  6. Free & operating cash flows: What's the Difference?

    Learn the difference between free cash flow and operating cash flow. Explore how analysts use earnings and cash flow to evaluate ... Read Answer >>
Related Articles
  1. Investing

    Corporate Cash Flow: Understanding the Essentials

    Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself. Learn how to read the cash flow statement.
  2. Investing

    Cash flow statements: Reviewing cash flow from operations

    Discover why cash flow from operating activities is significant to businesses, and learn the direct and indirect methods for calculating it.
  3. Investing

    Evaluating A Statement Of Cash Flows

    The metrics for the Statement of Cash Flows is best viewed over time.
  4. Investing

    Operating Cash Flow: Better Than Net Income?

    Differences between accrual accounting and cash flows show why net income is easier to manipulate.
  5. Investing

    Cash Flow From Investing

    Cash flow analysis is a critical process for both companies and investors. Find out what you need to know about it.
  6. Investing

    Fundamental Case Study: Is Amazon's Cash Flow Actually Solid? (AMZN)

    Review Amazon's cash flow situation, including its free cash flow yield, operating cash flow from organic growth and cash flow from debt financing.
  7. Investing

    Cash Flow Indicator Ratios

    Learn about the operating cash flow to sales ratio, free cash flow to operating cash flow ratio and free cash flow coverage ratio.
  8. Investing

    Cash Flow on Steroids: Why Companies Cheat

    Pressure to be the best can sometimes push corporations to cheat. Learn how they do it and how to spot it.
  9. Tech

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  10. Investing

    Cash flow statement: Analyzing cash flow from investing activities

    Here, you'll find an overview of cash flow from investing activities — one of three primary categories in the statement of cash flows.
RELATED TERMS
  1. Cash Flow Statement

    A cash flow statement is a financial statement that provides ...
  2. Cash Flow

    Cash flow is the net amount of cash and cash-equivalents being ...
  3. Cash Flow From Investing Activities

    Cash flow from investing activities reports the total change ...
  4. Net Cash

    Net cash is the result of a company's total cash minus total ...
  5. Business Activities

    Business activities are any activity that is engaged in for the ...
  6. Price to Free Cash Flow

    Price to free cash flow is an equity valuation metric used to ...
Hot Definitions
  1. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  2. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  3. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  4. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  5. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  6. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
Trading Center