Cash earnings

From CEOpedia | Management online

Cash earnings (also income) are excess of revenue earned by an entity over the costs that must be incurred to earn revenue (Begg, Vernasca, Fischer, Dornbusch 2014, p. 203-206).

Specificity of cash earnings

Income is the combination of the cash inflows received by an entity over a specified period of time and the costs necessary to earn those inflows. Individuals' cash earnings can nowadays be understood as a stream flowing from a variety of sources of goods and services (so-called income in kind) and amounts of cash (so-called monetary income) (Begg, Vernasca, Fischer, Dornbusch 2014, p. 203-206). Income is earned as a result of the production of goods and services, non-refundable transfers (pensions, annuities), and the provision of gainful employment. It may also come from capital or assets and other activities.

Cash earnings theories

According to Begg, Vernasca, Fischer S., Dornbusch, when dealing with the concept of income, the source of income must be taken into account first and foremost. There must be something that brings income. Income is inextricably linked to the notion of the factor from which income flows (Begg, Vernasca, Fischer, Dornbusch 2014, p. 203-206). The notion of income is also connected with the notion of income stability. And here it should be noted that in the opinion of this author, if we obtain a one-off surplus of income over the cost of obtaining it, we are dealing not with income, but with profit. On the other hand, in order to talk about income, the surpluses obtained must result from a fixed source. Following this trail of income is not everything that comes from such sources as donations, inheritances, sale of assets, or other occasional income that is not related to the proper activity generating income (Begg, Vernasca, Fischer, Dornbusch 2014, p. 203-206).

Consumption fund theory

Different theories of the understanding of cash earnings can be divided into two main groups. A narrower group for defining income is the so-called consumption fund theory. According to this theory, income is the income that can be used by a person who is in a certain period of time and without depletion of his or her assets (Fulmer, Finch, Smythe, Payne,2002 p. 14-19).

A broader theory of accepting cash earning as pure property growth

The second group of defining income consists of a broader theory of accepting income as pure property growth. According to this theory, income is a pure increase in property, achieved in a certain period of time. Then all pure income, uses, the value of third parties, legates, inheritances, donations, compensations, benefits, and lottery winnings are included in the income (Besanko 2012, p. 8-9) . Income is a major obstacle to our ability to meet our needs. It is like a barrier that sets a limit to what we can afford to meet our needs. Income determines the maximum expenditure we can incur on the purchase of goods and services. As our income grows, we can afford to meet our needs more broadly (Besanko 2012, p. 8-9).

Income tax

The phenomenon of income is closely related to income tax and the period in which the income is earned, as income is the taxable base. Actual income can only be determined after the end of the period in which it is earned, which is usually the marketing year. In this state of affairs, the precise definition of the concept of income and the rules for determining it become even more important (Osgood, 2004, p. 4-7). Against the background of this reasoning, numerous discrepancies have arisen, e.g. whether the income to be taxed is the resources obtained or those consumed or assimilated (e.g. savings), in other words, a question has been asked whether the income is to be taxed at the moment of its creation or during its spending (Osgood, 2004, p. 4-7). It has been assumed that the tax base is income at the time of its creation, i.e. the income is the resultant of income and costs of obtaining it. There are doubts related to the scope and catalogue of costs that are related to obtaining revenues (deducted from tax) and costs that cannot be deducted as tax deductible costs (Osgood, 2004, p. 4-7). In modern tax systems, only the monetary form of income has been abandoned. The nature of income has also been extended to include the concept of potential cash earnings (Fulmer, Finch, Smythe, Payne,2002 p. 14-19). This satisfaction can go two ways (Boex 2015 p. 2-4):

  • the first is to buy more individual goods,
  • replacing goods of worse quality, but cheap, with goods of better quality, better meeting our needs, but more expensive, i.e. those which we could not afford to buy on a lower income. All added value is someone's income.

Measurements of cash earnings

In national accounting there are different measures of income. National income is GDP less depreciation and sales taxes and excise duties and adjusted for net factor ownership payments. Personal income is national income less social security contributions and undistributed profits of joint-stock companies, plus transfer payments and interest paid to consumers by the state. disposable income is personal income after deduction of income tax(Hall, Taylor 2000, p. 69).

Advantages of Cash earnings

Cash earnings bring several advantages to businesses, including improved liquidity, increased profits, and reduced risk.

  • Improved liquidity: Cash earnings can provide businesses with additional sources of working capital that can be used to maintain operations or expand.
  • Increased Profits: Cash earnings can be used to help generate higher profits by reinvesting in the business or providing additional funds for growth.
  • Reduced Risk: Cash earnings can reduce the risk of investing in other businesses or markets, since the cash can be used to pay off debt or other obligations.

Limitations of Cash earnings

Cash earnings provide an incomplete measure of the financial performance of a company because they do not take into account the timing and structure of cash flows, the cost of capital and other non-cash items. The following are some of the limitations of cash earnings:

  • Cash earnings do not consider the timing of cash flows, which can be delayed or accelerated due to the timing of income and expenses. For example, cash earned from sales may not be received until after the goods have been delivered, and cash outflows from expenses may be paid before the benefit of that expense is realized.
  • Cash earnings do not take into account the cost of capital, which is the cost of financing a company’s operations. This cost is not included in cash earnings, but can have a significant impact on a company’s overall financial performance.
  • Non-cash expenses or income are not included in the cash earnings. These can include items such as depreciation, amortization, and gains or losses on the sale of assets.
  • Cash earnings do not consider any potential non-operating income or expenses, such as interest income or losses, which can affect a company’s overall financial performance.
  • Cash earnings are affected by the amount of cash on hand and the company’s ability to generate cash from operations. This can have a significant impact on a company’s ability to meet its obligations.

Other approaches related to Cash earnings

Cash earnings can also be measured from different angles, such as:

  • Operating Cash Flow (OCF): Operating Cash Flow is the cash generated from operations, which can be calculated by deducting operating expenses from the gross income.
  • Free Cash Flow (FCF): Free Cash Flow is the cash remaining after all paying back to investors, creditors and other stakeholders. It is calculated by subtracting capital expenditure and other non-cash expenses from Operating Cash Flow.
  • Cash Flow from Investing (CFI): Cash Flow from Investing is the cash generated from the selling and purchase of long-term assets, such as real estate and other investments.
  • Cash Flow from Financing (CFF): Cash Flow from Financing is the cash generated from the activities related to debt and equity financing, such as issuing and repaying loans and issuing and repurchasing shares.

In summary, cash earnings can be measured from four different angles, namely Operating Cash Flow, Free Cash Flow, Cash Flow from Investing and Cash Flow from Financing. Each of these metrics provides a different perspective on the performance of the company and should be considered when assessing the financial health of the business.

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Author: Natalia Jaskot