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 value of a fixed asset arising out its revaluation, and profit on sale of a fixed asset.
An 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 Profit & Loss Account. This entry has no cash flow implication and therefore does not pass through the Cash Account.
If a revaluation gain has been credited to Profit & 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 Profit and Loss Account but credited direct to a Revaluation Reserve Account.
In such a case, the net profit disclosed by the Profit & Loss Account is not affected by revaluation and should therefore not need to be adjusted for preparation of cash flow statement. Profit on sale of a fixed asset is a slightly tricky issue. When a fixed asset is sold at a profit, the amount of cash inflow is larger than the net reduction in value of fixed assets.
When preparing the Cash Flow Statement, the actual amount received on sale of the fixed asset is shown as a source of cash. As this amount is greater than the net reduction in the relevant fixed asset’s balance, profit on sale as included in the Profit & Loss Account should be deducted from Net Profit figure. Another reason for excluding this gain from the net profit figure is the fact that profit on sale of a fixed asset is not a normal operational activity.
The Net Profit figure, as shown in the Cash Flow Statement. as a source of cash should represent the cash generated by the business during the year from its normal operational activities. Hence, profit on sale of a fixed asset should be deducted from the Net Profit figure.