Netflix is a particularly interesting example for understanding how a company can report growing profits while spending more cash than it generates from its activities.
For much of the 2010s, Netflix presented two very different results in its financial statements. The income statement showed positive and growing net income, while the statement of cash flows showed negative cash flows from operating activities.
How can a company report a profit while also having substantial cash outflows?
The answer mainly relates to how Netflix invests in films and series and to the rules of accrual accounting.
Why is there a difference between net income and operating cash flow?
Netflix spends substantial amounts on producing films and series and on acquiring streaming rights to various content.
When the company produces or acquires the rights to a film or series, the related costs, if they meet the recognition criteria, are initially recorded as assets on the balance sheet. These are known as content assets.
Their entire cost is not necessarily recorded as an expense in the year the payments are made. Instead, it is allocated over the period of use through amortization, also taking into account the expected pattern in which subscribers will view the content.
This means that Netflix can pay for content today while recognizing the related expense in the income statement over several years.
To make this easier to understand, suppose Netflix incurs and pays $100 million for a series. If only $30 million of this cost is recognized as amortization expense in the first year, then:
That year's profit is reduced by $30 million because of amortization.
The company has paid $100 million to produce the series.
Leaving other factors aside, the effect on operating cash flow is an outflow of $100 million.
Therefore, the expense recognized in the accounts and the actual cash payment do not necessarily occur in the same period.
An important feature is that Netflix classifies payments for film and television content within operating activities in its statement of cash flows, unlike ordinary purchases of long-term assets, which are generally classified as investing activities.
This helps explain why Netflix could report positive net income and negative operating cash flow at the same time.
How did Netflix's financial position change?
For many years, Netflix continuously invested in new content to attract subscribers and expand into international markets.
These investments required large payments that often exceeded the amortization expenses recognized during the same year. As a result, operating cash flow remained negative even though the company continued to report profits.