PUBLICATION OF THE NEBRASKA BUSINESS DEVELOPMENT CENTER
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M
any equate the success of a company to its
reported prots. While prots are good, they
do no adequately represent the nancial
standing of a rm. It is quite possible for a company
to report prots but go out of business. It is also pos-
sible for a company to be protable and not be able to
grow, secure nancing, or attract investors. There are a
couple of reasons why cash ows are a better indicator
of a company’s nancial health.
Cash is King
Prot gures are easier to manipulate because they
include non-cash line items such as depreciation ex-
penses or goodwill write-offs. Under generally accepted
accounting principles (GAAP) businesses can use non-
cash expenses such as depreciation and amortization
to offset large capital expenditures.
Cash ow statements, on the other hand, provide
a more straightforward report of the cash available.
In other words, a company can appear protable “on
paper” but not have enough actual cash to replenish its
inventory or pay its immediate operating expenses such
as lease and utilities.
If a company cannot purchase new inventory, it will
slowly become unable to generate new sales. If a
company cannot afford its operating expenses, it will
eventually go out of commission. Either way, “Cash is
King” in keeping a business alive.
Cover the gap between
receivables and payables
Another important consideration is that prot reports
are based on sales income. The main issue here is that
the recorded revenue is often greater than the amount
of actual cash received from sales. When sales are on
credit, the collection period on
accounts receivable can last 2-3
months. This means that the
company needs to have enough
cash on hand to oat its opera-
tions for the duration of the col-
lection period.
Using the previous examples,
this means having the cash equivalent of 2-3 months’
worth of operating expenses and inventory purchases
on hand. In the likely event that a rm also makes
purchases on credit, accounts payable become another
important factor to consider. To be sustainable, a busi-
ness has to pay special attention to its cash cycle and
make sure to cover the cash gap between receivables
and payables.
Why cash ow is more important than prot
It is quite possible for a company to report prots but go out of business. It is also possible for a
company to be protable and not be able to grow, secure nancing or attract investors.