Profit Is More Important Than Cash — Discuss
Cash and profit are two terms that are often confused in business studies as being the same thing, but it is important to distinguish between them if we are able to analyse businesses correctly. Simply put Cash is notes and coins either in hand or at the bank, while Profit is the difference between income and costs yet both can occur at different time scales. You can’t spend profit, you can only spend cash. Both need to be examined to find which is the more important.
Profit is considered to be long term; it shows whether or not a business is making money. How much profit a business appears to be making in its accounts could be an incentive to a number of people outside the business. Shareholders are a particularly important group in the way that they may receive a share of the profits in the form of dividends. How much profit a business is making usually decides how much of this money they get, along with the number of shares they hold.
The idea is much the same for those wishing to invest in the business. If they feel the company is performing well due to it having high profits they may choose to invest their money in order to get something back on it. For businesses then, showing high profits on the profit and loss account could be beneficial in that attracting more investors would lead to an influx of cash that all businesses would appreciate. Although depending on how much or how badly a business needs cash still doesn’t make a distinction between which is the most important.
Of course if businesses appreciate extra cash no matter what their liquidity they will probably strife to keep their investors happy. Showing the uphold of good dividends to these people could come about through retained profits. Monitoring profits like this could mean that it is profit that is more important than cash. Retained profit is money that is kept in the business at the end of the financial year. It contributes to shareholders’ funds on the balance sheet reserves.
The financial gain for them just from holding shares in a business will probably mean profit is the more important to shareholders in this respect. Yet some may be concerned whether these dividend payouts can be sustained. Retained profits can assist with this in that the higher they are a firm is able to pay higher dividends in the future most importantly keeping shareholders happy.
Profit to is important in that due to business having close relationships with their banks, which are responsible for supplying them with credit; if a firms profit looks good yet they need more cash the bank may be willing to lend with the confidence that in time this business will be able to make this money back. The problem here though is that because the accounts are a snapshot in time of a firm’s financial position, they may be experience cash flow problems not apparent in the accounts and so may just be making things worse for themselves, which brings me onto the importance of cash.
Cash has an immediate significance in that without it and good cash flow, though a business may be profitable it could still end up going bust because it runs out of cash. Probably the most important component of cash flow is a firm’s working capital, which is money used to cover the day-to-day running costs of the business. Here the focus is on cash alone. Being able to pay things like creditors and bank loans if important in avoiding a business getting into trouble.
If these problems are avoided it can mean cash can be a great assets in expanding and make a business better. The cash can be used so that it has a direct effect on profit in the long term such as by buying more machines to increase capacity utilisation. The monitoring of cash flow in such a situation is important so as to avoid overtrading, which brings about extra problems.
The importance of cash then does not just lie within the boundaries of the firm concerned but also with others that it is associated with; in particular it’s creditors. Overtrading can put a strain on working capital because there is not enough long-term finance. If word gets out that a business is suffering cash flow problems its creditors may demand early payment. Here cash is important for the outside party because if its debtor is unable to pay what it owes this company too could end up in an equally worse financial position.
There are repercussions from such situations like businesses not being so trustworthy in the future and looking for orders and sales elsewhere and so careful management of cash in essential.
Overall it probably depends on the situation of the business. Through the accounts a business may appear to be financially healthy or unhealthy but it may be that the case is in fact the opposite, only they will truly know. Most people setting up in business and even existing businesses look to make a profit. It is like an indicator that all work has been done for a reason, yet sometimes it may just be that profit is an added bonus. For instance business starting up will look to survive there first few years and so they are going to find cash the most important aspect of the business; that is why most offer evidence to lenders of cash flow forecasts to show it has been thought about.
The importance of cash to the larger, more established businesses is less so. Another instance is where large companies like DFS have huge cash reserves in order to cover those day-to-day costs. What they concentrate more on is achieving great profits. Then there are times when businesses become concerned about both profit and cash at the same time like during cash flow problems. Selling an asset can solve the important problems in the short term but it may mean that profits are affected in that utilisation has been reduced and so less can be produced and then sold.
|© 2004 — 2011, НаЭкзамен. ру. All right reserved.