Definition and Explanation
Just as non-cash expenses do not result in cash outflow, non-cash incomes do not lead to cash inflow and must, therefore, be excluded from the year’s profit.
The two examples of non-cash incomes are appreciation in the value of a fixed asset arising out of its revaluation, and profit on the sale of a fixed asset.
Appreciation in the value of a fixed asset arising out of its revaluation is obviously only a book entry. A gain on revaluation of a fixed asset is debited to that asset’s account and credited to the profit and loss account.
This entry has no cash flow implications and, therefore, does not pass through the cash account.
If a revaluation gain has been credited to the profit and loss account (thereby increasing the year’s net profit figure), it should be deducted from the net profit figure to arrive at the correct cash flow generated by operational activities.
Care should, however, be taken if the gain on revaluation has not been credited to the profit and loss account but credited directly to a revaluation reserve account.
In such cases, the net profit disclosed by the profit and loss account is not affected by the revaluation. As a result of this, it does not need to be adjusted for the preparation of the cash flow statement.
Profit on the sale of a fixed asset is a slightly tricky issue. When a fixed asset is sold at a profit, the cash inflow is larger than the net reduction in the value of fixed assets.
When preparing the cash flow statement, the actual amount received on the sale of the fixed asset is shown as a source of cash.
Given that this amount is greater than the net reduction in the relevant fixed asset’s balance, profit on sale, as included in the profit and loss account, should be deducted from the net profit figure.
Another reason for excluding this gain from the net profit figure is the fact that profit on the sale of a fixed asset is not a normal operational activity.
The net profit figure, as shown in the cash flow statement, should represent the cash generated by the business during the year from its normal operational activities. Hence, profit on the sale of a fixed asset should be deducted from the net profit figure.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.