Cash Flow vs. Profit

1. Cash Flow vs. Profit • CAUTION: Do not confuse cash flow with profit

2. Cash Flow vs. Profit • Cash Budget Net cash flow • Income Statement  Profit or net income • Profit and Loss or P&L • Statement of Income • Statement of Operations

3. Cash Flow vs. Profit • Record of cash transactions • Single-entry accounting system (check book register?) • Monthly cash flows table (pp. 23-25 in packet) • Monthly cash budget (pp. 26-27 in packet) • Double-entry accounting system (pp. 17-22 in packet)

4. Cash Flow vs. Profit Net Cash Flow (2010 cash budget, pp. 26-27 in packet) =Cash operating receipts $795,918 -Cash operating disbursements $535,716* -Cash interest payments $12,771* +Sale long-lived assets $18,768 -Purchase long-lived assets $26,049 +Principal borrowed $0 -Principal repaid $8,368 -Income & social security taxes $33,782 ±Savings withdrawals/deposits +$10,000 ±Non-business flows -$64,233 = $143,767

5. Cash Flow vs. Profit • Net Cash Flow does not reflect profitability • Does not reflect true depreciation • Generally, does not reflect tax depreciation • Varies with tax depreciation rules, particularly Sec. 179 & bonus depreciation

6. Cash Flow vs. Profit • Net Cash Flow does not reflect profitability • Generally, cash from selling long-lived assets is not revenue • Net cash flow may include non-business flows • Does not account for changes in inventory and other relevant items

7. Cash Flow vs. Profit • Short Run • Cash available vs. cash required • Cash must be available when needed • Feasibility • Info tool = cash budget

8. Cash Flow vs. Profit • Long Run • Revenue > opportunity costs • Management provided by owners family • Labor provided by owners family • Profitability • Info tool = income statement

9. Cash Flow vs. Profit • Scenario 1 • Cash balance declines by $50,000 • Net farm income after taxes = $140,000

10. Cash Flow vs. Profit • Scenario 2 • Cash balance increases by $50,000 • Net farm income after taxes = $40,000

11. Cash Flow vs. Profit Accounting for net income Cash basis Accrual basis Accrual adjusted (FFSC statements)

12. Cash Flow vs. Profit Cash basis: record revenue only when cash is received (receipt) and record expenses only when cash is paid (expenditure) Ease of record keeping (check book register?) Basis for cash income tax reporting (also requires tax depreciation records)

13. Cash Flow vs. Profit Net farm profit Schedule F/cash method = Cash operating receipts • Cash operating disbursements (including interest) • Depreciation = $160,576 Gains and losses appear on other tax forms Complete 2011 Schedule F

14. Cash Flow vs. Profit Schedule F • Most farmers use the cash method because they find it easier to keep records using the cash method. However, certain farm corporationsand partnerships and all tax shelters must use an accrual method of accounting.

15. Cash Flow vs. Profit • The following businesses, if engaged in farming, must use an accrual method of accounting. • A corporation (other than a family corporation) that had gross receipts of more than $1,000,000 for any tax year beginning after 1975. • A family corporation that had gross receipts of more than $25,000,000 for any tax year beginning after 1985. • A partnership with a corporation as a partner. • A tax shelter

16. Cash Flow vs. Profit Cash basis net income Calculation of net income requires information about depreciation and gains and losses

17. Cash Flow vs. Profit Cash net farm income after taxes =Cash operating receipts - Cash operating disbursements - Depreciation - Cash interest payments + Gain from disposition, long-lived assets - Loss from disposition, long-lived assets - Income & s.s. taxes = $140,604 in 2010 (p. 28 in packet)

18. Cash Flow vs. Profit Accrual basis: revenue is reported when it is earned, whether or not cash has been received, and expenses are recorded when they are incurred, whether or not cash has been paid Information is typically maintained within a double-entry accounting system, and the matching concept is typically applied

19. Cash Flow vs. Profit Accrual adjusted: cash net income is adjusted for changes in assets and liabilities, typically at the end of the year Does not require double-entry accounting Matching concept is typically not applied

20. Cash Flow vs. Profit Accrual-adjusted net farm income after taxes = $253,691 in 2010 (p. 29 in packet) Cash net farm income after taxes ±Adjustments for changes in: Inventories Receivables Payables Prepaid expenses Accrued expenses

21. Cash Flow vs. Profit • Adjustments to Cash Net Income* • Increase in asset  Net income • Increase in liability  Net income • Decrease in asset  Net income • Decrease in liability  Net income *Adjustment to revenue is opposite from adjustment to an expense

22. Cash Flow vs. Profit • Asset vs. Liability??? • Paid insurance premium for the next six months • Took delivery of feed but have not paid

23. Cash Flow vs. Profit • Asset vs. Liability??? • Borrowed money six months ago and now owe $326 interest • Sold hogs but have not received check

24. Cash Flow vs. Profit • Accrual Net Income • Reduces distortions from cash accounting • Why do farmers prefer the cash method? • Income taxes • Ease of use

25. Cash Flow vs. Profit • Flexibility in order of events (Revenue) • Produce • Sell • Receive payment (cash flow)

26. Cash Flow vs. Profit • A cash receipt may not be revenue • Revenue may not be a cash receipt • Adjust for: • Accounts receivable • Product inventories

27. Cash Flow vs. Profit • Flexibility in order of events (Expense) • Give payment (cash flow) • Take possession • Use

28. Cash Flow vs. Profit • A cash disbursement may not be an expense • An expense may not be a cash disbursement • Adjust for: • Accounts payable • Prepaid expenses • Accrued expenses • Input inventories

29. Cash Flow vs. Profit • Revenue vs. cash receipt • Expense vs. cash disbursement • Matching concept • Expenses are deducted when revenue is realized • Work in process → Cost of goods sold • Our FFSC income statement is not consistent with this concept (financial accounting vs. managerial accounting)

30. Cash Flow vs. Profit • Accrual NFIAT is a return to: Owner equity Unpaid labor Unpaid management