Introduction
When evaluating the financial health of an organization, investors or business organizations usually search for a single metric to incorporate in the financial statements for determining their investments or business strategy. Organizations commonly compare the significance of net income or cash flow during such circumstances. Therefore, the research provides a comprehensive comparison between net income and cash flow, the importance of understanding cash flow for non-finance leaders, and ways in which non-finance leaders can utilize cash flow statements to optimize the performance of their organizations.
A Comparison between Net Income and Cash Flow
In accounting cash methods, net incomes and cash flows are considered similar. However, the concepts are significantly different in the accrual accounting method since accrual methods track incurred expenses and accrued incomes. Net income is company profits earned during a particular period. It is a profitability metric and a primary driver for bond valuation and stock prices. On the contrary, cash flow is the measure of operating activities that evaluates incoming and outgoing cash during daily business operations. As cash flow records an increase or decrease in cash balances, net income illustrates accounting profits recorded by the company. Both cash flow and net income are crucial metrics in determining the financial health of an organization.
Reasons Why Non-Finance Leaders Need Understanding of Cash Flows
Although several investors equate a company’s success to reported net income, good profits do not provide the background financial strength of an organization. A company can record profit but still needs to secure investors, grow, and receive financing from banks. Using the accounting guidelines of GAAP, companies can use non-cash like amortization or depreciation to settle high capital spending. As a result, the organization can appear profitable, but it needs more cash to meet operating expenses and purchase inventory. On the contrary, cash flow provides a clear report on cash present in the firm. The inventory can clearly illustrate if an organization cannot meet its expenses or buy new sales. According to Laghari et al. (2023), cash flows are crucial for optimizing the financial performance of an organization, meeting consumer satisfaction, and implementing effective strategies for achieving service expenses as they determine the working capital. Adequate cash flows help manage working capital available in completing transactions and running business day-to-day activities. By keeping track, cash flow statements ensure short-term obligations are settled. Thereby helping to maintain a company’s stability and financial health and improving customer satisfaction.
Cash flows provide flexibility for settling unexpected expenses or venturing into new opportunities. When an organization’s cash flow increases, its liquidity also rises (Wisan, 2023). When non-finance managers gain such knowledge in cash flow, they can understand when to hire new employees or invest in additional equipment to utilize a sudden rise in demand. According to Wisan (2023), adequate cash flows provide an advantage to firms to venture into emerging ideas without disrupting the daily operations of a business. Consequently, understanding a business’s cash flow enables non-finance managers to evaluate the business’s creditworthiness, chances of growth through external financing, and budgeting and planning using cash flow forecasting. Before lending a company funds or investing in a project, investors usually evaluate a firm’s creditworthiness. Understanding the cash flow process can help managers maintain a positive cash flow effectively in gaining quick external financing. Also, cash flow forecasting provides predictions of future outflow and cash inflow in budgeting and planning, which are crucial in making informed decisions. Therefore, when managers understand cash flow, they can project future problems and identify ways to mitigate them before they affect the organization.
Ways Non-Finance Managers Can Utilize Information from Cash Flow Statements
Non-finance managers can use information from cash flow statements to measure impacts, determine budgets, and eliminate unnecessary expenses. As a manager, tracking the effect of the presented efforts on the company is crucial. A manager gains insights into whether a firm has enough liquidity or cash for running day-to-day operations from an equipment purchase through a cash flow statement. Also, cash financial statements are crucial for providing historical data essential in making predictions in budget planning. Notwithstanding, cash flow statements provide a display of company expenses. Therefore, managers can gain highlights of areas that are unnecessary and should be eliminated.
Conclusion
Both net income and cash flow are crucial for determining the financial health of an organization. Net income is an essential metric in business since it represents the leftover funds after distributing money to shareholders and settling expenses. A manager can decide whether to reinvest it into the business or save. However, when comparing cash flow with net income, cash flow has presented some significant benefits to managers. Since cash flows cannot be manipulated easily, they are essential in determining a firm’s creditworthiness, the impact of operations, and budget planning.
Summary Page
Net income is company profits earned during a particular period. It is a profitability metric and a primary driver for bond valuation and stock prices. On the contrary, cash flow is the measure of operating activities that evaluates incoming and outgoing cash during daily business operations. The two metrics are crucial for investors when assessing the financial health of an organization. Although net income is an excellent way to evaluate a company’s success, profits are more easily manipulated than cash flows. Therefore, as a non-finance manager, cash flows have several advantages in maintaining an organization’s performance.
Cash flows are essential in planning, evaluating the creditworthiness of an organization, and determining a firm’s chances of growth using external financing. Before lending a company funds or investing in a project, investors usually evaluate a firm’s creditworthiness. Understanding the cash flow process can help managers maintain a positive cash flow effectively, which in turn helps them gain quick external financing. Also, cash flow forecasting provides predictions of future outflow and cash inflow in budgeting and planning, which are crucial in making informed decisions.
When running business operations, non-finance managers can utilize cash flow statements to measure impacts, plan budgets, and determine unnecessary costs. As a manager, tracking the effect of the presented efforts on the company is crucial. A manager gains insights into whether a firm has enough liquidity or cash for running day-to-day operations from an equipment purchase through a cash flow statement. Also, one can identify extravagant expenses that disrupt company operations through CFS. As cash financial statements are historical data, they are essential in making informed decisions during budget planning in the future.
References
Laghari, F., Ahmed, F., & López García, M. D. L. N. (2023). Cash flow management and its effect on firm performance: Empirical evidence on non-financial firms of China. Plos one, 18(6), e0287135. https://www.ncbi.nlm.nih.gov/pmc/articles/PMC10281586/
Wisan, J. K. (2023). The Importance of Using The Statement of Cash Flows Assessing Company Liquidity. AvailableatSSRN4339305.https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4339305
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