1. Net Income Versus Cash Flow
Lecture No.24
Professor C. S. Park
Fundamentals of Engineering Economics
Copyright © 2005

2. Taxable Income and Income Taxes
Item
Gross Income
Expenses
Cost of goods sold (revenues)
Depreciation
Operating expenses
Taxable income
Income taxes
Net income

3. Example 8.8- Net Income Calculation
Item
Amount
Gross income (revenue)
$50,000
Expenses
Cost of goods sold
Depreciation
Operating expenses
20,000
4,000
6,000
Taxable income
Taxes (40%)
8,000
Net income
$12,000

4. Allowed depreciation expenses (not cash flow)
Capital Expenditure versus Depreciation Expenses 1 2 3 4 5 6 7 8
Capital expenditure
(actual cash flow)
$28,000 1 2 3 4 7 6 7 8
$1,250
$3,500
$2,500
$2,500
$2,500
$4,000
$4,900
$6,850
Allowed depreciation expenses (not cash flow)

5. Cash Flow vs. Net Income
Net income: Net income is an accounting means of
measuring a firm’s profitability based
on the matching concept. Costs become
expenses as they are matched against
revenue. The actual timing of cash inflows
and outflows are ignored.
Cash flow: Considering the time value of money, it is better
to receive cash now than later, because cash
can be invested to earn more money. So,
cash flows are more relevant data to use in
project evaluation.

6. Why Do We Use Cash Flow in Project Evaluation?
Example: Both companies (A & B) have the same amount of
net income and cash sum over 2 years, but Company A returns
$1 million cash yearly, while Company B returns $2 million
at the end of 2nd year. Company A can invest $1 million in year
1, while Company B has nothing to invest during the same period.
Company A
Company B
Year 1
Net income
Cash flow
$1,000,000
1,000,000
Year 2
2,000,000

7. Example 8.9 – Cash Flow versus Net Income
Item
Income
Cash Flow
Gross income (revenue
$50,000
Expenses
Cost of goods sold
Depreciation
Operating expenses
20,000
4,000
6,000
-20,000
-6,000
Taxable income
Taxes (40%)
8,000
-8,000
Net income
$12,000
Net cash flow
$16,000

8. Net income versus net cash flow
Net cash flows = Net income + non-cash expense (depreciation)
$50,000
Net income
Net
cash flow
$12,000
$40,000
Depreciation
$4,000
Income taxes
$8,000
$30,000
Gross
revenue
$6,000
Operating expenses
$20,000
$10,000
$20,000
Cost of goods sold $0