While experiencing negative cash flow with a negative net income seems more obvious, a company can also have a positive net income but a negative cash flow for the same year if it uses the accrual method of accounting to record revenues and expenses. Under the accrual method of accounting, net income can be increased by non-cash revenues that don't affect cash flow, whereas cash flow can be decreased by actual cash payouts that may not be considered expense deductions for net income.
As a result, while sufficient non-cash revenue may help achieve a positive net income, enough non-expense cash payouts can lead to negative cash flow, all else being equal.
What Is Net Income?
Net income is an accounting profit that is not measured by cash receipts and cash payouts, and it's one of the important income statement items. Companies may make credit sales and receive no cash payments from customers at the time, but still record revenues in computing net income. Meanwhile, companies record no cash inflows from the sales.
Assuming that a company paid cash for expenses incurred and had no other cash inflows for the year, given that revenues exceeded expenses, the company would have a positive net income, but a negative cash flow for the year.
Consider also: Net Income Vs. Taxable Income
Effects of an Asset Increase
Cash flow for the same year can be further reduced by other cash payouts that are not counted as expenses incurred and, thus, don't lower net income. Cash paid to increase certain operating assets for the year, such as inventory purchase, is a form of cash outflow that, if large enough, could reduce total cash flow to be negative.
Companies may also prepay certain expenses for the future that are recorded as incurred expenses only over time. As a result, while the entire prepayments are deducted for cash flow, only a portion of it, as incurred expense for the year, is subtracted for net income.
Effects of a Liability Decrease
Companies also make cash payments to reduce operation-related liabilities, namely various payables. Payables are the results of accrued expenses from earlier periods that have not been paid in cash.
At the time of the expense incurrence, net income was reduced, while cash flow was not affected. However, in the year of paying off an outstanding payable, the cash payouts have no impact on net income, but will reduce cash flow for the year. If large amounts of payables are all due in the same year, their total cash payouts could cause cash flow to be negative.
How Cash Flow Works
Total cash flow also includes cash outflow from non-operating activities, specifically investing and financing activities. Investment purchases and the return of borrowed principal are two main sources of cash outflows.
While investment losses from investment sales in investment activities and interest expense on borrowed funds in financing activities are subtractions for net income, the amount of investment purchases and the amount of principal payback are bigger subtractions for calculating cash flow. The larger the difference between the two types of subtractions in their relative amounts, the more likely cash flow may become negative and net income maintain positive.
Consider also: The Advantages of Cash Flow