The Business Book

152152

C A S H I S K I N G

PROFIT VERSUS CASH FLOW

F

or new businesses, fast-

growing companies, and in

times of recession, cash is

king. In other words, profit takes a

back seat, while cash flow becomes

the critical factor. In accounting,

profit is an abstract concept based

on matching costs to the revenues

generated within a period of

trading. This sounds fine, but in

practice it can lead to a huge

cash shortfall. For example, if a

construction business links its

costs to the time when the finished

houses are ready for purchase,

it has ignored the huge cash

outflows that are incurred during

the building process, and might

run out of cash before the houses

are sold. When times are good, a

In times of economic

stability companies focus

on profit; credit is cheap

and readily available.

Companies with weak

cash flow operate by

using supplier credit

and overdrafts.

But in times of recession, relying

on credit is dangerous.

Cash is king.

IN CONTEXT

FOCUS

Financial management

KEY DATES

1957 John Meyer and Ed Kuh

publish “The Investment

Decision,” the first study to

look at cash flow and

investment in businesses.

1987 The US Financial

Accounting Standard Board

(FASB) introduces a new

requirement: companies must

now complete an annual

“statement of cash flows” in

addition to a balance sheet,

income statement, and

retained earnings statement.

2013 The UK’s Co-operative

Bank abandons its plans to

purchase 632 branches of

Lloyds Bank, because it has

insufficient cash to buy the

business and run the branches.