Profit and Have No Cash? Term Paper

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will go up in the fourth quarter, they could end up ordering for more pieces of the same so as to satisfy the anticipated demand. Assuming that the company purchases 400,000 units of Product Q. At a total of $2,000,000, it would have only $100,000 left in its coffers. Assuming that the consignment arrives on time but the expected increase in demand for Product Q. does not come to pass, the company could be left holding stock worth $2,000,000. Although, the business is still profitable (assuming it continues to sell the normal 100, 000 units), it could find itself broke to an extent where it may not be able to finance capital projects. This is more so the case given that the normal revenues it gets could be tied up in other commitments. In other words, although the business could be making a profit, it could still be cashless.

A business could also find itself with no cash on hand despite making a profit in other numerous instances due to poor planning and imprudent decision making. This is more so the case in those instances where a business entity decides to make a prepayment for the future only for the said prepayment to be recognized as an incurred expense over time. For instance, the executives of Company XYZ could purchase a multi-year comprehensive insurance package in the month of July and pay up front for the said cover. Assuming that the total amount of money paid in this case is $500,000, what the company essentially does is make present payment for insurance coverage running so many years into the future. It should in this case be noted that accounting rules permit a business entity to claim only a faction of such an expense annually.

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Assuming that Company XYZ's profits for the year were $300,000, a more informed look at the scenario reveals that the company's cash flows are actually negative. Thus while Company XYZ's Finance Manager could report a profit of $300,000, the company in effect has a negative cash flow of $200,000 ($500,000 - $300,000). Should nothing be done to remedy the situation at this point, the company could end up running out of cash to oversee day-to-day operations despite having reported a profit. It is clear from the above scenario that net income as Brigham and Ehrhardt (2011) observe "is not equal to the cash flow available for distribution to investors" (p.425).

Lastly, it should also be noted that a business could deem it fit to reduce or dispose off payables incurred in previous periods. In this case, although net income was reduced at the time the expense was incurred, the transaction did not affect actual cash flows. During repayment however, cash flows for the year will be reduced. The net income in this case is not affected. Should the repayment be large, then we could end up with a situation whereby the business is cash strapped despite having made profits.

Conclusion

Although the text above highlights scenarios whereby a business could be profitable but cash strapped of broke, it is also important to note that the reverse could also be true. A business could be unprofitable but cash rich. Such a situation could be as a result of a business' aggressive utilization of loans. Thus in the final analysis, although negative cash flows are clear indicators of poor financial operations, positive cash flows do not necessarily indicate proper or good financial operations......

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