When discussing the financial health of a business, people often use the terms “net income” and “cash flow” interchangeably. This is technically incorrect, as the two concepts are very different. While it is important to understand the distinction between them, it is also important to recognize that they both have an impact on the financial health of a business.
Also known as “net profit” or “the bottom line,” net income is the amount of money that a company has left over after all expenses have been paid. It is calculated by subtracting all expenses, including cost of goods sold, taxes, and operating costs, from total revenues. Net income is the amount of money that a business must pay out to shareholders, reinvest in the business, or use to pay down debt.
Cash flow, on the other hand, is the amount of money that a business has coming in and going out. It is calculated by taking the total amount of cash that a business has on hand at the beginning of a period and adding any new cash that came into the business (ex: sales), and then subtracting any cash that left the business (ex: expenses). Cash flow is an important indicator of the financial health of a business, as it shows how well the business is managing its money.
What’s the difference, and why should you care?
The main difference between net income and cash flow is that net income is a measure of profitability, while cash flow is a measure of liquidity. Net income measures the profitability of a business by looking at the net amount of money that is left after all expenses are paid. Cash flow, on the other hand, measures the ability of a business to generate and manage cash. Cash flow is important because it shows how well a business can pay its bills and reinvest.
Net income is a measure of the long-term performance of a business, while cash flow is a measure of the short-term performance.
- Net income is a measure of the overall profitability of a business over time and is used to determine the value of a business.
- Cash flow, on the other hand, is a measure of how well a business is managing its money in the short-term and is used to determine how much money a business needs to pay its bills and invest.
Both net income and cash flow are two metrics that are critically important in understanding the financial health of a business and managing a business’s finances.