Net Income Versus Cash Flow (2)
Posted on January 30, 2009 - Filed Under Finance
Here is another way of looking at cash flow versus accounting income: If Sunnyvale showed no net income for 2004, it would still be generating cash of $6,405,000 because that amount was listed as an expense but not actually paid out in cash. The idea behind the income statement treatment is that Sunnyvale would be able to set aside the depreciation amount, which is above and beyond its operating expenses, this year and in future years. Eventually, the accumulated total of depreciation cash flow would be used by Sunnyvale to replace its fixed assets as they wear out or become obsolete. Thus, the incorporation of depreciation expense into the cost, and ultimately the price structure, of services provided is designed to ensure the ability of an organization to replace its fixed assets as needed, assuming that the assets could be purchased at their historical cost. To be more realistic, businesses must plan to generate net income, in addition to the accumulated depreciation funds, sufficient to replace existing fixed assets in the future at inflated costs
or even to expand the asset base. It appears that Sunnyvale does have such capabilities as reflected in its $7,860,000 net income and $14,265,000 cash flow for 2004.
It is important to understand that because of accrual accounting the $14,265,000 cash flow calculated here is only an estimate of actual cash flow for 2004, because almost every item of revenues and expenses listed on the income statement does not equal its cash flow counterpart. The greater the difference between the reported values and cash values, the less reliable is the rough estimate of cash flow defined here. The value of knowing the precise amount of cash generated or lost has not gone unnoticed by accountants. In Chapter 4, readers will learn about the statement of cash flows, which can be thought of as an income statement that is recast to focus on cash flow.
Taken From : HEALTHCARE FINANCE
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