Cash vs. Income – Do you know the difference?

Reason #1: Non-Cash Expenses on the Income Statement

The income statement is a financial statement that you use to calculate how much income your company generates. Naturally, the more expenses you can deduct, the lower your taxes are. As a result, companies deduct as much as the IRS allows, and some of those deductible expenses are non-cash.

Two of such non-cash expenses are depreciation and amortization and are related to the use of fixed assets. The IRS allows these deductions to encourage companies to invest into their business. While the actual cash outflow for those investments happens at the time the purchase is made, the non-cash deductions occur over a period of time those assets are used.

The third non-cash expense is called bad debt expense. It is present only when companies extend credit to their customers and is an estimate of the write-off, or the amount they anticipate they won’t be able to collect.

Reason #2: Accrual Accounting

Accrual accounting is the method commonly used for creating financial statements. Under this method, companies record revenues and costs when they are incurred, and not when the cash transfer takes place. For example, if the company allows its customers to pay on credit, it will record revenues when the sale is made, but will only receive cash when the customer pays later.

Reason #3: Cash is Spent On Operations, Investing, and Financing

All companies use cash in three ways: operations, investing, and financing. Cash flow from operations is most closely connected with the income statement, but it is not equal to net income for the reasons described above. In addition, companies use cash on investing activities (asset purchases or sales) and financing activities (receiving or re-paying investments and shareholders distributions).

To learn more about the basics of accounting and financial analysis, we recommend you take Class #1 – Financial Statements and Analysis For Early Stage Software and Service Startups.

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About Victoria Yampolsky, CFA: Victoria Yampolsky, CFA, is the President and Founder of The Startup Station, a comprehensive financial resource for early stage startups. She evaluates the financial feasibility of business models and specializes in the financial modeling and valuation of pre-revenue companies. She also created a finance curriculum for early stage founders and launched The Startup Station’s educational program in 2015. Since then, more than 1,000 founders have attended her online and in-person finance classes and learned the basics of financial modeling, valuation, and startup financing.

Previously, Victoria worked for the Deutsche Bank Research Department and performed IT consulting for CapGemini’s Financial Services Division. Victoria holds a Bachelor’s Degree, Cum Laude, in Computer Science, with minor in Mathematics, from Cornell University and an MBA, with honors, from Columbia Business School. Victoria is also on the Advisory Board of the CIS Department of Cornell University.