Cash flows from operations

Cash flow from operating activities is closely related to net income. It begins with the net profit for the period, and then adjustments are made.

An important detail is that while cash flows from operating activities are closely linked to the profit determined in the income statement, the two values are not necessarily equal.

It is common to confuse profit with cash flow from operations, but there is a difference due to time lags between when something is earned/expensed and paid.

An example of where this is relevant is if you have sold something to a customer and recognized the revenue, but the customer has not paid your invoice yet.

In this instance, the income statement will include a profit, but the cash flow from operations should not. to reflect that you haven't received any money yet. The cash from operations will in this case be down-adjusted via the increase in operational assets (accounts receivable).

Profitability is a better indicator of performance, but cash flow is needed to pay the bills

Changes in current assets and liabilities can get a little abstract, so let’s take a look at a few examples that follow the balance sheet equation.

Example 1: you sell a good or service worth $500. The customer pays next period.

Example 2: You buy inventory for $2,000

Example 3: Customer prepays $2,400 for service over 12 periods