Cash Earnings
Cash earnings, also known as cash flow from operations or operating cash flow, is a financial metric that represents the cash generated by a company’s core operating activities during a specified period, typically a quarter or a year. Cash earnings differ from net income, as net income is calculated using accrual accounting, which includes non-cash items such as depreciation and amortization.
Cash earnings provide a more accurate picture of a company’s financial health and liquidity by focusing on actual cash inflows and outflows rather than accounting for non-cash items. This metric helps investors and analysts evaluate a company’s ability to generate cash from its operations, which is crucial for meeting financial obligations, making investments, paying dividends, and supporting growth.
Cash earnings can be calculated using the following formula:
Cash Earnings = Net Income + Non-Cash Expenses – Non-Cash Income
Non-cash expenses typically include depreciation, amortization, and provisions for bad debts, while non-cash income may consist of items such as unrealized gains on investments or income from equity-accounted investments.
Alternatively, cash earnings can be calculated using the indirect method from the cash flow statement:
Cash Earnings = Net Income + Depreciation and Amortization + Changes in Working Capital
In this formula, changes in working capital represent the net changes in assets and liabilities related to a company’s operating activities, such as accounts receivable, inventory, accounts payable, and accrued expenses.
A high level of cash earnings indicates that a company is generating a significant amount of cash from its operations, which is a positive sign for its financial stability and growth prospects. On the other hand, low or negative cash earnings may suggest that the company is facing challenges in generating cash from its core business activities, which could raise concerns about its ability to meet financial obligations and invest in future growth.
Example of Cash Earnings
Let’s consider a hypothetical example of a company, “ABC Manufacturing Inc.” We’ll calculate its cash earnings using its financial statement data.
From ABC Manufacturing Inc.’s financial statements, we have the following information:
Net Income: $500,000
Depreciation: $100,000
Amortization: $25,000
Increase in Accounts Receivable: $50,000
Increase in Inventory: $30,000
Increase in Accounts Payable: $60,000
Unrealized Gain on Investments: $20,000
First, we calculate the changes in working capital:
- Increase in Accounts Receivable: -$50,000 (negative because cash inflow is reduced)
- Increase in Inventory: -$30,000 (negative because cash outflow is increased)
- Increase in Accounts Payable: +$60,000 (positive because cash outflow is reduced)
Total Changes in Working Capital: -$50,000 – $30,000 + $60,000 = -$20,000
Next, we calculate the cash earnings using the formula:
Cash Earnings = Net Income + Depreciation and Amortization + Changes in Working Capital
Cash Earnings = $500,000 + $100,000 + $25,000 – $20,000 = $605,000
In this example, ABC Manufacturing Inc.’s cash earnings amount to $605,000. This figure represents the cash generated by the company’s core operating activities during the specified period. The cash earnings provide insight into the company’s ability to generate cash from its operations, which is essential for meeting financial obligations, funding investments, paying dividends, and supporting growth.
A high cash earnings figure, like the one in this example, indicates that ABC Manufacturing Inc. is generating a significant amount of cash from its core business activities, which is a positive sign for its financial stability and growth prospects.
