Any company that shows regular earnings but simultaneously shows no balance of cash is considered to be of not very good fiscal stature. With regards to the statement “How Can My Company Have Income but No Cash?” the first and foremost thing required to be understood is the difference between the terms “income” and “cash”. Income can be understood as the net disposable income available at the disposal of the company. Income as defined by Ernst & Young is “ Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that results in increases in equity other than those relating contributions from equity participants” (121). Such net income can be arrived at by deducting all expenses from all the proceeds of the concern. Cash can be understood as that current asset available with the firm which can be used to repay any current liabilities at a short period of notice and also to purchase equipments machinery etc. Cash as defined by Ernst & Young is “Cash on hand and demand deposits” (2566).
Having understood the definitions of both the terms, what needs to be analyzed is the connotation of the statement “How Can My Company Have Income but No Cash? As discussed in the previous paragraph a company that though shows income but is experiencing a cash crunch cannot be regarded as a financially sound company. But there can be an exception to this assumption in the following situations: where the company did not receive payments from its customers who have already been supplied with their deliveries of goods or services, the company might have paid its suppliers much ahead of time, investing in the purchasing of any capital asset.
In the present case, the net income at the disposal of the firm for the period is $60,000. According to the policy adopted by Stevenson, 80% of the reported profit shall be withdrawn from the company. Effectively $48,000 ($60,000*80% = $48,000) shall be withdrawn by Stevenson from the company. Consequently, the company now only has a cash balance of $12,000 ($60,000 - $48,000). Though the income of the company for the particular period may be recorded at $60,000, the cash retained in the company as per the withdrawal policy adopted is only $12,000.
Therefore, a clever balancing act shall be pursued while maintaining adequate cash levels in the company so as to project sound financial health of the company and enhance the credibility of the company among the prospective investors etc. in the presence of adequate income, if there are no appropriate cash balance available with the company, the short term liquidity of the firm shall definitely go for a toss while disturbing its creditworthiness among the creditors and reliability among the prospective investors.
There are serious tax implications with regards to the retaining of profits in the business or distributing it to the owners. As per the Internal Revenue Service’s rules, a certain tax shall be levied on the retained earnings of the business in the event of excessive retaining of profits in the business. Therefore, effective cash management definitely means a lot to any concern whether it is large or small and whether it is in profits or losses.
References
1. Ernst & Young. International GAAP 2008: Generally Accepted Accounting Practice Under. West Sussex: John Wiley & Sons Ltd. 2008. Print.
2. Bari R.R. Cash Planning and Management. Delhi: Triveni Publication. 2000. Print.
