Whether you are a chartered accountant or the owner of a small to large business enterprise, this article on cash flow vs net worth will be extremely important for you.
Cash flow and net worth are the fundamental instruments for determining the financial health of a company or enterprise. While cash flow denotes the amount of money that enters and exits a company, business, or organization daily, net worth denotes the health of a company, business, or organization by providing a picture of the company’s current financial position, stock, or inventory.
Let’s dive into the details of cash flow and net worth.
What are Cash Flows?
Cash flow, also known as the virtual motion of money, is defined as the net sum of money, resources, wealth, or assets generated by a company, business, or organization throughout its working phase.
The net operating cash flow is measured by finding the difference between the total amount of outgoing cash of the company from the total amount of incoming cash of the same company.
To put it simply, cash flow is the calculation of the inflow minus outflow made by a company over a duration of time.
Cash Flow = Total Inflow – Total Outflow
Cash Flow Format & Example
Here’s an example of cash flow format computation of a company’s operating activities:
- To calculate the operating, investing and financing activities of cash flow, start with the net income (net income will be discussed in detail below).
- Now add the non-cash items, i.e., those not expensed in cash (e.g., amortization and depreciation).
- Consider doing the same for the sales of assets. If the company has faced the loss of assets, add the amount. If the company gained a profit on the sales of assets, consider subtracting the amount.
- Next, consider the changes that occurred with regards to the non-current asset during the year.
- Lastly, put in or subtract any changes made to the current assets or current liabilities. However, keep in mind that current liabilities do not involve the dividend payable and note payable.
What is a Net Worth?
Net worth, also known as the shareholder’s equity or book value, is defined as a quantitative monetary gauge that determines a company’s financial health and position.
Net worth is measured by finding the difference between the total amount of liabilities owed by the company from the total amount of wealth owned by the same company.
In other words, net worth is the calculation of the value of the total assets earned minus the total debts or liability value of a company over the duration of time.
Net Worth = Total Assets + Total External Debts or Payables
Is there any difference between Net Worth & Net Income?
Though the terms Net Worth and Net Income sound almost similar and are often used interchangeably, there are a lot of differences between them:
- Net worth is the value of an individual or companies’ assets minus their liabilities or debts. Net income is the money or revenue earned from performing a task or operation minus the expenses.
- Net Worth = Total Assets – Total Debt or Liabilities
- Net Income = Total Revenues – Total Expenses
- Net income is the fundamental source for individuals or businesses to build up wealth. Net worth helps to establish a better understanding of that wealth.
- Net income doesn’t confirm whether or not wealth will increase. Net worth does it.
Net Worth Format & Example
We have already seen the relationship between net income and cash from an operation conducted under the “Cash Flow Format & Example” section.
Now, after taking the net income or profit into consideration, we need to add back or subtract the specific adjustments, and we will find out the net cash flow from operating activities under the indirect method of cash flow.
Cash Flow vs. Net Income
|Net Income||Cash Flow|
|Net income is the money or revenue earned from performing a task or operation minus the expenses.||Cash flow is income minus expenses.|
|Net Income = Total Revenues – Total Expenses||Cash Flow = Total Income – Total Expenses|
|Net income is the fundamental benchmark for gaining profit by driving stock prices.||Cash flows help in performing operations by adapting to the net income by excluding non-cash items like amortization and depreciation that are more likely to misinterpret the company’s true financial status.|
|Net income is simply the final profit the company gains even during situations where there is no proper flow of cash. In such cases, companies or businesses are more likely to lose more money than earn it.||A company or business that has better cash flow preparation is more likely to earn more revenue.|
What’s more important, Net Worth or Cash Flow?
Even though cash flow and net worth are considered equally important in the world of real estate passive investing, there have been more net worth problems in comparison to cash flow problems.
Here are the main reasons why cash flow is comparatively more important than net worth:
- Cash flows are better at paying for the regular payments or bills of your day-to-day life situations, necessities, investments, luxuries, etc., than net worth.
- Businesses with high cash flow effectively avoid debts, pay their creditors, pursue more opportunities, engage more with investors, and build a more successful future than those with a high net worth.
- Cash flows are easier to track and predict than net worth. A strong cash flow can easily determine whether you will be generating income for years or not.
- Net worth is just an estimate of an individual or a business’s financial stability and is not liquid like cash flows. If you need cash urgently for any reason, having a high net worth won’t help you at all.
How Slate helps you keep tabs on your business cash flow effectively
At Slate, we assist businesses by efficiently managing their financial cash flow preparation by displaying the status of their money in distinctly coherent reports. The technology used at Slate helps arrange and track all your accounts and transactions properly on a monthly basis.
With all these monthly insights on balance sheets, visual reports, and income statements, we help companies gain a thorough understanding of the financial status and rankings of their business.