The Difference between Accounting Revenue and Actual Cash Flows

written by: Jennifer Rivers; article published: year 2007, month 01;


  

In: Categories » Legal and finance » Accounting » The Difference between Accounting Revenue and Actual Cash Flows

There are significant differences between accounting revenues and profits and the company's cash flow. These differences may derive from several sources, such as the following:

  • Timing differences between sales and receipt of payments— The main differences are the result of timing differences between when sales are made and when payment for them is received. Cash will flow to the company only when payment is received for a transaction it made, unless the company has made an agreement whereby it sold the debt related to the sale to a finance provider, who gave it cash in consideration for the debt.

  • Barters— Besides the provision of credit to customers, another difference results from transactions in which the consideration is not given in cash. Such barters are far more common among high tech companies, and particularly startups, than in other companies. The reason for this is that in many cases neither party has the cash required to pay for various services and products it consumes. Therefore, they render services or supply other products, whose cost to the supplier is low, but that have a high market value, in consideration for products and services consumed by the company. The price at which such transactions are recorded is the subject of constant discussion by the authorities. Without going too much into accounting rules, the customary rule is that the price of barters must be based on the market price of similar transactions. One of the indicators of such price is similar transactions recently performed by the company in consideration for cash.

  • Accounting depreciation— Another material factor that creates a vast difference between the revenue and the cash generated by a company's business is investment in fixed assets such as communication networks or equipment. Although these assets may be paid for in cash, they serve the company over long periods of time. They will appear in the company's balance sheet and be reflected in the income statements only by depreciation over their expected useful life span, generally several years.

    Let us assume, for example, that a certain software development company buys equipment which it can use for two years for $1,000. Therefore, every year $500 will appear as an expense in the income statement to reflect the depreciation of this asset. Let us further assume that the payment for the equipment was made in cash. In the year it bought the equipment, the company was still engaged in development, and incurred additional expenses of $2,000 for salaries. In that year, the company will report expenses of $2,500, namely the depreciation of the equipment and the salaries paid. The company's cash account, however, was reduced in that year by $3,000 for the same equipment bought and salaries paid. In the following year, the company finishes developing the product and sells it for $4,000, paid in cash, having incurred expenses of $1,000 for advertising (paid in cash), $2,000 for salaries and another $500 for the depreciation of the equipment. The company will therefore report a profit of $500, although its cash account increased by $1,000.

  • Leasing and relying on credit from suppliers— Many startups significantly reduce their cash needs by making intensive use of leasing, i.e., receiving long-term credit (usually from the manufacturer or an entity specializing in this type of financing) to finance equipment that is received by the company immediately but is not legally owned by it. The manner by which such transactions are recorded in the income statement depends on many variables pertaining to the economic ownership of the asset. Another customary form of financing is relying on credit from suppliers, i.e., receiving credit from suppliers in order to pay for a purchase.

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