Cash Earnings

You’ve probably heard the quote “revenue is vanity, profit is sanity, cash is reality” before.

It’s yet another adage used to talk about the importance of cash flow. The thought is no matter how much revenue or profit you record, nothing trumps the reality of how much money ends up in the bank.

Then the question is: if net income is how much profit you’re making but not how much cash you’re actually pocketing, what metric are you supposed to use to track your cash performance?

The answer is cash earnings.

What Are Cash Earnings?

Cash earnings are the net amount of money that a business generates from operations when looking at just cash activity.

When you look at your profit and loss statement (or income statement), you see all of your revenues and expenses. But not every line item represents actual cash activity. Expenses like amortization and depreciation don’t represent cash activity because money doesn’t change hands.

With the accrual accounting method, your profit and loss statement is even further from your cash activity. Any revenues and expenses recorded might be unpaid accounts receivables and payables with the cash not yet being sent or received.

When calculating cash earnings, only include cash activity for the month, quarter, year, or period of time you’re analyzing. That means only including sales that you’ve received payment on and expenses that have been paid.

How to Calculate Cash Earnings

There are two main methods of calculating cash earnings.

One way of calculating cash earnings is by tallying up cash revenue and cash expenses. If you have clear records of cash activity, this is the easiest approach to take The calculation is then:

Cash Earnings = Cash Revenue – Cash Expenses

The more common approach to calculating cash earnings is to start with your net income and adjust for non-cash activity. This involves adjusting for things like non-cash expenses and unpaid invoices. If you take this approach, the calculation is:

Cash Earnings = Net Income – Non-Cash Income + Non-Cash Expenses

This information is found in your accounting and financial reporting.

Look at your profit and loss statement for your net income and to review non-cash expenses. Your balance sheet will tell you what you need to know about changes in accounts receivables and payable balances.

With those two common financial statements, you can calculate your cash earnings.

Why You Should Track Cash Earnings

There are many ways of measuring your business’s performance. No one metric is the perfect representation, but when you piece together multiple financial metrics, you start to get the full picture.

Net income is not always a good representation of how money is entering or exiting your business. Cash earnings strips away the noise so you can focus on just the activity that’s impacted your bank account.

Think of net income as measuring the theoretical performance of your business. If you have a positive net income or you’re hitting your goals for that metric, you’re clearly doing something right.

But if you want to plan for your future, create a budget, or understand what you can put away for savings, you’ll want to know the actual cash impact of your operations. Cash earnings is a much more practical metric to use when making decisions based on your cash levels.

Analyzing Your Cash Earnings

The first thing you should look at when analyzing your cash earnings is how it compares to your net income.

If your cash earnings are less than your net income, don’t jump straight into panic mode. There are many valid and non-anxiety-inducing reasons why your cash earnings are lower than your net income. Take the time to find out why and you’ll put yourself at ease while learning about your business in the process.

Commonly, businesses have lower cash earnings than net income over a period of time because of collections issues. If you’re racking up sales but the payments take weeks or months to come through, your cash earnings will take a hit.

Another example of when cash earnings lags behind net income is businesses with a subscription revenue model. Annual subscriptions are a windfall of money upfront and often the revenue “spread out” over the duration of the subscription. This results in recording income in later months that represents cash that’s already collected.

When analyzing cash earnings, always take a look at the following factors:

• Review non-cash expenses: If you recently had high capital expenses, your amortization or depreciation will also be high. This drives net income down but does not affect cash earnings.

• Look into receivables turnaround times: Long payment times mean more waiting before those sales make an impact on your cash balances. Consider changing your payment terms with discounts or penalties to incentivize quicker payment.

• Understand the impact of payables: Is your business blindsided by bills? Reach out to the supplier to see if there’s an option to change the billing cycle. It’s a small way to control when cash is leaving your business and improve cash flow.

An Example Of Calculating Cash Earnings

A landscaping company is looking at its most recent quarter of performance. They want to expand their operations by hiring a new employee, but only if they generated enough cash in the previous quarter to cover their annual salary of $65,000.

On their profit and loss statement, it shows a net income of $60,000. It seems like they’ve missed their goal until their finance team wants to run the numbers one more time, this time looking at cash earnings.

Looking at their balance sheet, their accounts payable balance increased by $6,000 and their accounts receivables increased by $2,000. They also recorded $1,000 in depreciation expenses for the quarter.

Plugging these numbers into the cash earnings equation, we get:

Cash Earnings = Net Income – Non Cash Income + Non Cash Expenses

Cash Earnings = $60,000 – $2,000 + ($6,000 + $1,000)

Cash Earnings = $65,000

By looking at cash earnings, you might find you’re actually bringing in more money than expected. For goals that are tied to cash balances, looking at cash earnings is a much better way to track your progress.

Cash Earnings vs. Cash Flow

Cash flow is another metric businesses use to understand how their cash balances are trending.

Similar to the cash earnings calculation, the cash flow formula involves taking your net income and adjusting for any non-cash activity like unpaid invoices, depreciation, or amortization.

The key difference between cash earnings and cash flow is that cash earnings are specifically looking at cash from your operations. Cash flow includes all cash activity including financing and investing.

For example, if you get a $10,000 loan, your cash balances go up by $10,000. Cash flow would include that change, but cash earnings would not as it didn’t come from operations.

Which one is better to track? Like all metrics, they both have their uses and value.

For startups or businesses seeking investment or credit to hit their expansion goals, cash flow is extremely valuable to track their progress toward big purchases or growth plans. But cash flow doesn’t report on how sustainable their operations are as the business could be cash positive from taking on debt or new investment.

When you track cash earnings, you’re learning about how cash runs through your business, but more specifically how cash is driven from your operations. Whether it’s a bank, investor, shareholder, or yourself, cash earnings will be used to understand how sustainable a business is without investment or debt.

Tracking Cash Earnings (and Other Metrics) With Ease

It’s unlikely you got into business because you love crunching numbers, and cash earnings is another number to crunch. Rather than working inside your accounting platform, what if you  had a financial platform that worked for you?

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