Have you ever heard of a business losing money but still having cash in the bank and continuing to generate cash monthly? It may sound like a financial impossibility, but it’s actually possible and happens more often than you might think.
While this concept might also seem confusing initially, it’s an important aspect of financial management that sheds light on the complexity of small company finance and accounting. Continue reading to learn more.
Negative Net Income vs. Positive Cash Flow
Negative net income, often called a net loss, occurs when a company’s total expenses exceed its revenues over a specific accounting period. This indicates that, on paper, the company is losing money.
Creditors often view negative net income as a red flag. It tells them that a business may struggle to meet its debt obligations. Thankfully, alternative financing is now more available than ever. For example, many startups borrow with CreditNinja. It’s an online lender that caters to startups and small and medium enterprises (SMEs). They also tailor loans depending on their borrowers’ financial situation and capability.
On the other hand, positive cash flow refers to a situation where cash inflow into a business, project, investment, or financial product exceeds the cash outflow. This financial state indicates that a company has more money coming in from its operating activities, investments, and financing than it is spending.
A positive cash flow enables a business to settle debts, reinvest in its operations, return money to shareholders, and act as a financial buffer. It is a critical indicator of a company’s liquidity, operational efficiency, and overall financial health.
Can They Happen At The Same Time?
A business can report a negative net income while still experiencing positive cash flow. It’s essential to understand the distinction between cash and accrual accounting to grasp how it happens.
Here are their differences:
- Cash Accounting. Records revenues and expenses only when cash is received or paid. This method can present a skewed view of a company’s financial health if significant revenues have been earned but not yet received or expenses have been incurred but not yet paid.
- Accrual Accounting. Recognizes income when earned and expenditure when incurred, irrespective of the timing of cash exchange. This method provides a more accurate picture of a company’s financial performance over some time but can also lead to a scenario where a company shows a negative net income while still having positive cash flow.
The crux of this seeming contradiction lies in the difference between accounting profits (or losses) and cash movements. For example, a company may have substantial upfront cash receipts from sales or advance payments, reflecting a positive cash flow. However, under accrual accounting, if the expenses associated with generating those sales are high enough in the same period, this can lead to a negative net income.
How Does This Happen?
The first factor is non-cash expenses like depreciation and amortization. Imagine you own a delivery business, and you buy a new van. The cost of the van isn’t counted all at once. Instead, it is spread out over several years as depreciation.
This expense lowers your net income on paper but doesn’t take cash out of your bank account. Even if your income statement shows a loss, your cash flow can still be positive because you’re not actually spending cash on depreciation.
Another factor is working capital. If your business starts paying its bills a little later or collects payments from customers faster, you’ll have more cash on hand, even if your overall sales and expenses haven’t changed. This doesn’t mean your business is earning more, but more cash flows, keeping the lights on despite a net loss.
Moreover, a business might sometimes have to pay for big, one-off expenses like settling a lawsuit or restructuring. These costs can significantly dent the net income for the year. However, because these expenses aren’t regular, they don’t necessarily reflect the ongoing cash flow or the health of the business’s day-to-day operations.
Finally, spending on big projects or purchases, known as capital expenditures, can lead to a similar situation. For example, your business decides to expand and build a new store. The upfront costs are high, and they might lead to a loss in the short term.
However, the actual cash spent might have been saved up over previous years, or it might have been spread out through financing. That means while your income statement reflects a loss due to the current year’s expenses, your cash flow remains positive thanks to careful planning and saving.
Implications for Businesses
This scenario isn’t necessarily bad news. A company with negative net income but positive cash flow can still be in a healthy financial position, especially if the positive cash flow is sustainable and supports operational needs and growth investments.
In addition, companies in this position might need to evaluate their expenses, investment strategies, and operational efficiency. This will ensure not only cash flow sustainability but also long-term profitability.
For business owners and investors, understanding this concept is crucial. It’s a reminder that a company’s net income doesn’t tell the whole story. Instead, they should look beyond net income and consider cash flow to get a complete picture of financial health when assessing a company’s viability.
The idea that a business can have negative net income while still enjoying positive cash flow might seem counterintuitive. However, it’s a relatively common scenario that underscores the importance of a comprehensive financial analysis. Understanding the nuances behind these figures allows stakeholders to make informed decisions and develop strategies that align with the company’s financial realities and goals.
About BELAY Financial LLC
BELAY Financial LLC (www.belayfinancial.com) provides flexible contract CFO & Controller services to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, valuing businesses, and other financial management. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. BELAY Financial has a team of more than 45 professionals serving more than 120 companies, and is part of BELAY Solutions, a national firm providing virtual assistants, social media management, and accounting services to small companies.