Why can there be a substantial difference between net income and free cash flow?
A) Capital expenditures are not fully included in the net income calculation.
B) Free cash flow includes accrual items not found in net income.
C) Free cash flow does not deduct the same expense items as net income.
D) Net income only flows to retained earnings, while free cash flow can be used to pay dividends.

Question

Quizplus · Accepted Answer

Net income is calculated using accrual accounting, which records revenues and expenses when they are incurred, regardless of when the related cash transactions occur. As a result, capital expenditures, which represent cash outflows for long-term investments in property, plant, and equipment, are not fully included in net income. Free cash flow adjusts for non-cash items like depreciation and amortization, but also takes into account capital expenditures which are subtracted from operating cash flow to arrive at free cash flow. Thus, there can be a substantial difference between net income and free cash flow.

Why Can There Be a Substantial Difference Between Net Income