We all know that customers that don’t pay are simply taking money from your pocket and putting it into their own bank account. The best is to have no credit policy, and even collect cash in advance.
This is where the difference between a Net income Statement and a Free cash flow examples comes in. A Net Income Statement shows net income, based on cash income and accrued income as well as both cash expenses and accrued expenses. A Free cash flow examples shows free cash flow based on all the actual cash which the company earns, minus all the cash payments the company actually makes. A Free cash flow examples does not take into account accrued income, and it does not take into account accrued expenses which have not yet been paid for in cash.
However, you have to be careful when using the term profit or net income. It means you earn, but it doesn’t necessarily mean that you earn any actual cash. Why? Let’s say you sell a watch to someone. He picks up the watch from your shop and he promises to pay you 0 cash after 1 month. Do you record on your books that the sale happened today or one month later? Surprise, surprise! Based on generally accepted accounting principles (GAAP), you should record that the sale was made today. Not next month. Therefore, you can also already book your profit today. even if you didn’t earn any actual cash yet. This type of profit is called “accrued” income. You earn income even without collecting any cash yet.
The financial statements were just as easy to tackle. The first thing to do was the assumptions. To do that I simply took the selling price of my service (or product) and determined how much I would make in sales per day, week, month and year. That basic information was the basis for the remaining financial reports.
Being able to track a declining margin can give you a heads-up that you must adjust your prices or your costs. In the worst cases your gross profit and profit margin disappear altogether. At that point, you’ll be like the fellow who lost money on every sale but figured he could make it up in volume. Don’t do it.
By the way, if net income is a negative number, it’s called a loss. You want to avoid those. The net income is reflected on the Balance Sheet in the equity section, under current earnings (or net profit). Net income results in an increase in owner’s equity. A loss results in a decrease in owner’s equity.
When calculating P&L, one needs to ensure they are doing it in correspondence with the fiscal year. The fiscal year for a P&L is not determined by a calendar year, or by the lease year, but it can be. However, doing the P&L by the latter usually results in misleading information. Another element to consider is Capital. If a cost is capitalized then the amount is depreciated and spread over a period of time instead of being reflected on the P&L of the first fiscal year. In this way the P&L can, often times, reflect a lower cost for the year than the Cash Flow.
Interesting that it’s the same as the above rule of thumb. No coincidence here. If you were to die and wanted to make sure your dependents would continue to receive exactly what you brought home each month, they would need to completely replace your income forever. According to the Twenty Factor Model, having an insurance policy with at least 20 times your annual income will do.