What is the difference between operating cash flow and net income?
Net income is earned revenues minus incurred expenses. It follows gross income and operating income and is a final monthly, quarterly or annual report. A net income statement is important for potential investors and creditors, but it does not always show the company's actual development. For instance, after a high one-time asset sale, monthly net income may be higher than operating income, followed by much lower quarterly net income.
Total cash flow is the operative cash flow plus the net working capital of the company. The net working capital is the difference between assets and liabilities. The operative cash flow reports inflows and outflows as a result of regular operating activities. The best demonstration of operating cash flow is the cash cycle, which converts accrual accounting based sales into cash.
Cash flow and net income statements are different in most cases, because there is a time gap between documented sales and actual payments. The situation is under control if the invoiced customers pay in cash during the next period. If the payments are postponed further, there is a larger difference between net income and operative cash flow statements. If the trend does not change, the annual report may demonstrate equally low total cash flow and net income.
Usually, rapidly developing companies report low net income as they invest in improvement and expansion. In the long run, high operating cash flow brings a stable net income raise, though some periods may show net income decreasing tendency.
Constant generation of cash inflow is more important for a company's success than accrual accounting. Cash flow is a better criterion and barometer of a company's financial health. Managers and investors can avoid many traps if they pay more attention to operating cash flow analyses.