Are you confused between earnings and cash flow? You might think that earnings are basically cash flow flowing into the bank but you are wrong. They are actually two different things and they each have their own way of explaining if a company is a good investment for you.
How are Earnings and Cash Flows Different?
Earnings are money that the business gets through selling a product or service after misusing all the other expenses. Cashflow, on the other hand, is the amount of money going in and out of the company’s bank account. The two statistics help investors to evaluate a business but it is on two separate types of areas.
Earnings of a company will tell you about the performance of the company in the year and that would give investors an impression of how the company is able to hold themselves over their competitors.
As for cash flow, since the numbers are showing you the money in and out of the company, it will be able to tell you about the company’s ability to manage their funds. From here, you will be able to see for yourself if the company will be making money or are they having certain inefficiencies in terms of using their money for the business.
What is Earnings?
Earnings = Gross Profit – All Expenses
Gross Profit is derived from deducting your cost of sales from your sales revenue, meaning that you are using the selling price to minus away the cost price. This gives you the profit of the product sales, but you have to take into account that running businesses incur other expenses such as utility bills, wages and salaries, and marketing expenses.
Only by using your profits to minus off all your expenses then you will get your true earnings. You can then use the amount to track the performance of your business.
I have previously written an article that explains more about earnings and the other kinds of numbers that can be derived from earnings. Click here if you want to find out more!
What is Cashflow?
Cashflow is basically a net amount of cash that a business/company has. Cashflow is affected by the activities of a business that includes money in and out of their bank account.
One very simple example would be revenue when a business made a sale and that is money in. An example of money out would be paying for utility bills.
By knowing the cash flow of a company, you would be able to visualize where the money is coming from or what is making them lose money. A company with good cash flow would usually mean that they have good cash management and the business might be growing well.
Cashflow can be calculated by adjusting the net income to either add or subtract from revenue, expenses, and credit transactions (Only those who appear on both balance sheets and income statements) which causes transactions to take place from one period to another.
I will be talking about cash from operating activities, cash from investing activities, and cash from financing activities. All these numbers will be useful for you to know about the cash flow of a company.
I have also written an article about cash flow and the different types of cash flows. You can find out more by clicking here.
Non-Cash Earnings
There are instances where businesses would record down earnings that are not from cash. In fact, it is very common for businesses to buy/sell things on credit and this will be reflected in their financial statements as an account receivable instead of cash.
This means that accountants would usually record down the record as accounts receivable to acknowledge that revenue has been made but the cash has yet to come in. This will not affect cash flow as the business doesn’t have any money coming or out.
Non-Cash Expenses
Sometimes, the earnings reported of a company might be lower than cash flows because accountants are following the accrual method of accounting concepts. They record down expenses when they incur any expenses so that they would be able to match the revenue that would be needed to generate earning. Even though cash has not been paid for the expense. This is why the expense will not affect cash flow as cash is being conserved and the expense is still a liability.
Non-Earnings Cash
There are instances where cash is received in advance, this means that your earnings will not be affected as you have yet to be able to recognize that as an earning. In this case, your cash flow will be slightly overstated since you received cash in advance from your customers but you aren’t earning the money yet until you fulfill what the customers paid for.
The good thing about this is that the business would able to have more liquidity and commit their expenses using cash.
Non-Expense Cash
In cases where you pay for expenses in advance, it will not be recorded as an expense but as a prepaid expense which is an asset since you pay for the service before you have incurred the expense. In cases like this, your earnings will be higher since the expense have yet to be recognized while your cash flow will be lower since you have paid for the prepayment.
To Summarize
You have to know and differentiate between these two sets of numbers as they tell you different aspects of the business. This would help you to make better decisions before you invest in a company.
