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Cash flow is cash and is a fact. Net income is just an opinion

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  • Fernandez, Pablo

    (IESE Business School)

Abstract

A company's profit after tax (or net income) is quite an arbitrary figure, obtained after assuming certain accounting hypotheses regarding expenses and revenues. On the other hand, its cash flow is an objective measure, a single figure that is not subject to any personal criterion. In general, to study a company's situation, it is more useful to operate with the cash flow (equity cash flow, free cash flow or capital cash flow) as it is a single figure, while the net income is one of several that can be obtained, depending on the criteria applied. Profit after tax (PAT) is equal to the equity cash flow when the company is not growing, buys fixed assets for an amount identical to depreciation, keeps debt constant, and only writes off or sells fully depreciated assets. Profit after tax (PAT) is also equal to the equity cash flow when the company collects in cash, pays in cash, holds no stock (this company's working capital requirements are zero), and buys fixed assets for an amount identical to depreciation. When making projections, the dividends and other forecast payments to shareholders must be exactly equal to expected equity cash flows.

Suggested Citation

  • Fernandez, Pablo, 2006. "Cash flow is cash and is a fact. Net income is just an opinion," IESE Research Papers D/629, IESE Business School.
    • Handle: RePEc:ebg:iesewp:d-0629
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    File URL: http://www.iese.edu/research/pdfs/DI-0629-E.pdf
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    Cited by:

    1. Negrea Laura Georgeta & Matis Dumitru & Mustata V. Razvan, 2011. "Cash Flow Reporting And Creative Accounting," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 1(2), pages 597-602, December.
    2. Farhan, Jamil Ahmed, 2006. "Islamic Leasing and Auto Financing System in Pakistan in Compliance with Islamic Sharia," MPRA Paper 116439, University Library of Munich, Germany, revised 03 Jul 2022.
    3. Ion Madalina Viorica, 2018. "Factors of enterprise value - the privatization of ‘Sidex Galati’ Romania (case study)," Proceedings of the International Conference on Business Excellence, Sciendo, vol. 12(1), pages 466-475, May.
    4. Ali, Mazhar, 2015. "Impact of Operating Cash Flows on Capital Spending and Dividends," MPRA Paper 116415, University Library of Munich, Germany, revised 19 Oct 2022.
    5. Kausar, Muhammad Naveed, 2006. "An Overview on Auto Leasing Sector of Pakistan and Its Impact on Automobile Industry," MPRA Paper 116442, University Library of Munich, Germany, revised 05 Jul 2021.

    More about this item

    Keywords

    Cash flow; Net income; Equity cash flow; Free cash flow; Capital cash flow;
    All these keywords.

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