What is the difference between cash flow and income?

To put it simply: income is a measure of revenue, while cash flow is a measure of actual cash movement — income represents the amount of money earned from various sources (wages, interest, profits, etc.) over a specific period, while cash flow represents the inflow and outflow of cash during that same period.

For example, a business may generate significant revenue but still experience cash flow problems due to delayed payments, high operating costs, or other factors. On the other hand, a business may have modest revenue but manage its cash flow effectively, ensuring that it has the necessary funds to cover expenses and invest in growth opportunities.

Understanding cash flow is crucial for business owners, as it affects a company’s ability to pay its bills, invest in growth, and ultimately succeed. For example, a positive cash flow indicates that a business has more cash inflows than outflows, while a negative cash flow means the opposite. A negative cash flow may show that a business is spending more money than it’s earning, which could lead to financial difficulties.

What are the three types of cash flows?

Cash flow can be classified into three types:

  1. Operating cash flow: This type of cash flow represents the cash generated or used by a company’s day-to-day operations, such as revenue from sales and payments for expenses like salaries, rent, and inventory. It indicates whether a company can generate enough cash to fund its operations and shows the company’s ability to generate cash from its core business activities.
  2. Investing cash flow: This type of cash flow refers to the cash used or generated from investing activities, such as buying or selling long-term assets, property, or equipment. Examples of investing cash flows include buying or selling property, obtaining equipment, or investing in other businesses or securities. This cash flow category indicates whether a company is investing in productive assets that will generate future cash flows.
  3. Financing cash flow: This type of cash flow shows the cash used or generated from financing activities, such as issuing or repurchasing stock, paying dividends, or borrowing money. Examples of financing cash flows include proceeds from issuing stock or borrowing money and payments made for stock buybacks or debt repayments. This cash flow category shows how a company finances its operations and expansion and whether it uses debt or equity to fund its growth.

How is taxable income calculated?

On the other hand, taxable income is the portion of income subject to taxation by the government. It includes wages, salaries, tips, interest, dividends, and other income received throughout the year. However, some types of income, such as gifts, inheritances, and life insurance payouts, are generally not subject to taxation.

As reported on an individual income tax return, taxable income may not always reflect the actual cash the taxpayer receives, especially in cases involving ownership interests in pass-through entities like partnerships, S corporations, and limited liability companies.

These entities are generally not subject to taxes on income at the entity level, meaning that determining the actual gross cash flow of the taxpayer requires adjusting the tax return figures. (We have previously discussed pass-through entities and other business structures on this blog.)

To calculate your taxable income, subtract any deductions, like contributions to a retirement plan or interest paid on a mortgage, from your total income. The resulting amount is taxable according to your tax bracket (generally, the higher your taxable income, the higher your tax rate).

Why is cash flow not taxed?

Cash flow is not taxed because it is not considered to be a form of income for tax purposes. The movement of money in and out of an individual’s accounts can be used to pay expenses or debts. However, it is generally a better indicator of the liquidity of a business or individual and not an increase in wealth or the accumulation of assets.

While cash flow is not taxed, it can impact taxable income. For example, a business with a positive cash flow can invest in assets or pay off debts, reducing taxable income.

Similarly, if an individual has a negative cash flow, they may be able to deduct certain expenses or losses, which can also reduce taxable income.

Is a cash flow statement better than an income statement?

Both cash flow statements and income statements serve different purposes and provide specific information closely connected to the definitions of cash flow versus income explained above.

An income statement shows a company’s revenue and expenses over a specific period, typically one year. It provides a snapshot of the company’s profitability and helps investors and analysts determine the company’s ability to generate revenue and manage its expenses. The income statement measures a company’s operating performance, determines the cost of goods sold, and calculates net income.

In contrast, a cash flow statement provides a detailed analysis of a company’s cash inflows and outflows over a specified period. It shows how much cash is available to the company after accounting for expenses, taxes, and investments. The cash flow statement helps investors and analysts determine a company’s ability to generate cash and its liquidity, which is critical for ensuring it can pay its debts and invest in future growth.

The income and cash flow statements are essential for evaluating a company’s financial health. The income statement provides a measure of profitability, while the cash flow statement provides a measure of cash availability.

Both statements are needed to evaluate a company’s financial performance fully. However, some analysts argue that the cash flow statement is a better indicator of a company’s financial health, as it shows how much cash a company has and its ability to meet its financial obligations.

In closing…

Whether you’re a business owner or an individual, understanding the difference between cash flow and taxable income is essential for effective financial management.

Although they offer different sets of information, they are closely linked — for example, a cash flow statement could not exist without an income statement. So navigating the nuances and distinctions can be daunting.

Fortunately, you don’t have to do it alone. A professional tax accountant (like us!) can provide the expertise and guidance to help you confidently understand cash flow versus income, plan for your financial future, and achieve greater peace of mind.

Would you like some help?

If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 or contact us here to set up a time.

If you aren’t a client, why not? We can take care of your accounting, bookkeeping, tax, and CFO needs so that you don’t have to worry about any of them. Interested? Contact us here to set up a no-obligation consultation.

Stay informed

Interested in receiving updates in your mailbox? Check out our newsletter, full of information you can use. It comes out once every two weeks, and you can register for it below.