Accounting: A Company’s Financial Loss and Cash Increase
A company can report a net loss, yet there is an increase in cash for this entity. This is well explained by the fact of the existence of different components in the cash flows statements. The key components of the cash flow statement include financing, investing, and operating activities.
A company can have a 500,000 dollars loss but at the same time record a 750,000 cash increase. This can be caused by two main reasons. One of the most prominent explanations for an entity that recorded a loss to record positive cash flow is because of its depreciation. This is more specifically caused by depreciation expense. One of the effects of depreciation is to reduce the reported operating net income. In addition, it can increase the net loss reported. However, it is worth noting that the depreciation expense does not involve any payment in the form of cash.
An excellent example is a company that had acquired an asset in the year 2011 for $2,100,000. If such equipment is depreciated over a period of seven years, the depreciation expense accounted for in this year will be $300,000. This means that an amount equal to $300,000 is the one that is debited to the depreciation expense and credited in the accumulated depreciation account. Nonetheless, it is worth noting that there was no cash that left the accounts of this entity. This means that the company reported a loss of $50,000 with a non-cash depreciation charge of $300,000 then this means that this company’s cash increased by $250,000. In short, whenever a company reports a depreciation expense, it does not translate to the company incurring an expense in the financial statement. This means that by deducting the depreciation expense in the income statement, the company may record a loss, but the cash values have increased.
Another explanation involves accrual accounting. This is the method of accounting where revenues generated must be tallied with the expenses incurred in earning such revenues. In other words, this system of accounting ignores the factor of time and considers only expenses generate what in terms of revenue. This is checked even if payments have not been made. In other words, the accrual basis of accounting measures the financial performance of a company with no regard to whether any transactions have occurred or not. Using this method, the events are recognized by matching revenues obtained with the expenses that were incurred to obtain the revenues.
In the real accounting of the organization, it must therefore report and record the expenses the moment they are incurred even before the firm makes the invoice. An excellent example is a company with an accounting year that ends on December 31 but has a large expense at the end of the same year. The invoice for this transaction is due in February next year. This means that the net income for the year 2011 is markedly reduced, but the cash of this firm is not touched until next year. Another case is where a company receives cash in the form of deposits from a customer at the end of the year 2012.
The revenue will be earned in the years 2013. This means that the cash of this firm will have increased, but its net income and revenues will only increase in 2013. Dutta notes that all these are the methods that can be used to manipulate the cash flows to look attractive, yet the company is making losses. From the above analysis, the friend should not be worried as this happens in the normal running of the company. From the analysis above, the increase in cash could be caused by the depreciation or the incurred of deposits which will be recognized in the next accounting period.