Treasury Team

Profit versus cash

03-05-2016 | by Ad van der Plas |

It all started in the 90 ‘s of the last century when the Securities and Exchange Commission (SEC) requested the Financial Accounting Standards Board (FASB) to provide guidelines for the presented net profit in financial statements. The idea was to help private investors make better comparisons between the various investment opportunities. The set out guidelines were made mandatory for all listed companies in the USA. The principles of the FASB guidelines – generally accepted accounting principles (GAAP) – were also adopted in the financial statements of unlisted companies and applied worldwide (IAS) and in The Netherlands (RJ).

It is important for companies to comply with Standard Guidelines in their external financial statements. The reported net profit, however, is not the key management information. The profit is based on “provision accounting” and includes lots of  expectations and assumptions that are far from sure. For example the calculated amounts for pension provisions, depreciation, actual investment and accrued revenue are based upon big ifs and maybe’s. A better and more accurate tool of management is the free available cash flow. Ultimately, it is every company’s goal to make a bottom line cash surplus.

For investors the free available cash – and not the calculated net profit  – is the single most important information.

Investors in long-term-debt want to know if and when the company can pay back the interest and principal based on the generated cash.
Investors in equity capital want to know if the revenues on their investment have sufficient value for money compared to alternative yields such as mutual funds, bonds, savings accounts etc. All returns are compared based on  cash calculations.
Daily, weekly, monthly, quarterly and yearly the management need to know the turnover, margin, costs and net profit but most important : the actual generated cash and the use of capital. Why else would Warren Buffett believe that the real value of a company is determined by the total expected discounted net cash flow?

Want to know more about managing on cash ? Feel free to contact me.

Ad van der Plas – independent Treasury Consultant & Interim Manager
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