Why Your P&L Isn’t Telling You About Cash? DEBUNKING A COMMON MYTH! - Part 4

Why P&L Net Income Rarely Matches Registered Cash-in !

In the previous three posts, we explored the main reasons why Profit & Loss (P&L) net income and cash position rarely align. We discussed how depreciation and amortization are included in the P&L, even though they’re not actual cash expenses, while loan principal repayments, which are real cash outflows, are excluded. We also examined how the timing differences between invoicing and receiving payments can significantly impact the alignment of P&L and cash.

In the same spirit, the last source of discrepancy between P&L net income and cash position at the end of a period we will discuss relates to stock variation. Indeed, stock levels can significantly impact cash flow without immediately influencing the P&L, and understanding this relationship is critical for grasping why net income and cash often don’t match.

To be specific, when you purchase goods, the cash outflow is immediately reflected in your cash flow statement, as it directly impacts your cash position. However, under the accounting Matching Principle, which ensures that expenses are recognized in the same period as the revenue they generate, the cost of these goods will not appear in your P&L until they are sold. This is why an increase in inventory might reduce your cash flow without affecting the net income shown in your P&L.

Conversely, when you sell inventory that was purchased in a previous period, your stock levels decrease. Since the expense associated with this inventory was already recognized in an earlier period, no additional cash outflow is recorded in your cash flow statement. However, the expense is included in the P&L as part of the cost of goods sold (COGS), which reduces the net income. This is why a decrease in inventory can create a mismatch between your cash flow and net income.

These are the reasons stock variation creates a gap between net income and cash flow because inventory purchases and sales are recorded differently in financial statements.

In conclusion, always remember the P&L's net income alone doesn’t tell the full story. To truly understand your cash flow position, you must also consider factors like depreciation, loan repayments, receivables timing, and inventory levels, which means: only trust your cash flow statement!

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