There are several ways in which companies generate income. A company can generate income by borrowing from other financial institutions, investing in other activities or generally keeping good management of the core business that defines its existence. It is due to these differences in income generation that a cash flow statement is often divided into three sections: cash flows that are generated from financing activities, from investing activities and from operating activities. The section of a cash flow statement that deals with cash generated from operating activities always consider changes in working capital, any depreciation or amortization of the company’s assets and adjustments in the Net Income of the company. This paper attempts to give the difference between Net Income and Net Cash provided by Operating activities and further speculate which one of the two is a better measure of a company’s long-term profitability. Using a cash flow review of three restaurant companies, this paper will demonstrate the difference between the two.
Net income as defined by Robert & Daniel (1984) refers to the difference between a company’s total revenues and a company’s total expenses. Total revenue includes money earned from sales or investments while total expenses is the sum of money that a company spends in production of its goods and services, cash spent on rent and salary payments, depreciation expenses of the company’s assets and many more. Glenn, Anthony and Daniel (1991) interpret net income value as a representation of a net increase in resource, or a net decrease if it indicates a loss; that flowed into the business during that given financial period as a result of operating activities. Apart from providing information on its own, financial analysts use net income in comparison to other figures in financial ratios so as to determine a company’s financial health, for example, dividing net income by the average equity for that financial period so as to determine stockholder’s equity. Anthony and Leslie (1990) widely regard this ratio as the ultimate measure of overall accomplishment.
Net cash provided from operating activities, also referred to as operating cash flow, is realised by making further adjustments to the Net Income. Robert & Daniel (1984) indicate that within the income statement, there are several items that affect income but have no effect on the cash flow. In making these adjustments to the Net Income, the value obtained gives a better indicator of how much actual cash a business could have generated in a financial period. This value obtained is the net cash from operating activities Robert & Daniel (1984). In estimating the long-term profitability of a company, net cash provided from operating activities gives a good indicator than net income as it gives the actual cash a business could have generated in a financial period.
Reviewing the cash flow statements of the three restaurants in this assignment, Yum Brand, Inc. (December 30, 2006; December 30, 2005) shows an increase in its net income as well as the net cash provided by operating activities. Panera Bread Company (December 26, 2006; December 27, 2005) has a decrease in its net cash provided by operating activities, though its net income experienced a notable increase. Starbucks Company (October, 2006; October 2, 2005) shows an increase in both the net income and net cash provided from operating activities.
Panera company has a cash flow problem since the reduction in its net cash provided from operating activities indicates a decrease in the actual cash generated in that financial period (October 1, 2006; October 2, 2005).
Anthony, R. & Leslie K. (1999). Essentials of Accounting. Prentice: Prentice Hall Publishers.
Glenn, Anthony & Daniel. (1991). Managerial Accounting. McGraw: McGraw-Hill Publishers.
Robert, N. & Daniel, G. (1984). Fundamentals of Financial Accounting. New York: Journal of Financial Accounting.