How Can A Company With A Net Loss Show A Positive Cash Flow?
A prospect business owner client was asking me this question yesterday.
I shared my 2 pointers, it seems like a great enlightenment to him.
Let me share with you here….
A. Depreciation
1. A common explanation for a company with a net loss to report a positive cash flow is Depreciation Expense.
2. Depreciation expense reduces a company’s Net Profits (or increases its net loss) but it does not involve a payment of cash in the current period.
3. For example, if a company purchased equipment last year for $1.500,000 and depreciates the equipment over 5 years, its depreciation expense this year might be $300,000. This year’s $300,000 entry involves a debit to Depreciation Expense and a credit to Accumulated Depreciation. Not a penny left the bank account this year. (All $1.500,000 of cash left the bank account last year.) If the company’s income statement reports a loss of $50,000 after the $300,000 “non-cash” depreciation expense, its cash may have actually increased by $250,000.
B. Accrual Accounting
1. Another explanation involves Accrual Accounting.
2. A company must report its expenses as they are incurred and that is often before the company pays the invoice.
3. For example, a corporation with an accounting year ending December 31 might have a huge expense at the end of 2016, but the invoice is not due until January 2017. The 2016 net profits was reduced, but the company’s cash is not reduced until 2017.
4. Here’s one more example. A company might receive a deposit from one of its customers in December 2016, but will not earn the revenue until 2017. In that case, the corporation’s cash increased in 2016, but the corporation’s revenues and net income will not increase until 2017.
Hence, a business owner should be diligent enough to read the Income Statement, Balance Sheet and more important the Cash Flow Statement together in order to understand the full picture of his or her business performance.
Hope above pointers help. I am glad to share more if you are keen to be in the “know”.
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