Most business owners are not accountants and know enough about Net Income and/or Cash Flow to get by. Your financial statements are full of a wealth of information and each statement tells its own story of what is happening in your business.
While cash is King, the balance in you checking account doesn’t tell you what you are doing right or wrong in your daily operations. The Income Statement (aka Profit and Loss Statement) does. Sometimes Net Income is mistaken for cash flow. While the two items are related, they are not the same, especially if you use the accrual method of accounting or have depreciation and/or amortization expenses.
Net Income is the profit generated by your daily operations. This figured includes all of your sales (aka revenues) and expenses (such as rent, utilities, auto, meals, travel, depreciation, interest, etc.). Some of the expenses used to calculate Net Income are considered “non-cash” items, such as depreciation and amortization. However, depreciation and amortization do not impact cash flow.
If you use the cash basis method of accounting usually the only difference between your Net Income and Cash Flow will be the non-cash items. However, if you use the accrual method of accounting the difference between Net Income and Cash Flow will be a little more complicated to calculate because you have to take into consideration the changes in your Accounts Receivable, Inventory, Accounts Payable and many other accounts.
There is no general rule that says Net Income is always higher than Cash Flows or vice versa. It is a good idea to ask your bookkeeper to prepare both the Income Statement and Statement of Cash Flows each month so that you can track the trends of your operations and how those items impact how much cash you have in the bank.