Question

INCREASING CASH FLOW, DECREASING PROFIT

Lana Ferdinand, the owner-manager of a small proprietary company, had carefully monitored the cash position over the past financial year, and was pleased to note at the end of the year that the cash position was strong, and had shown a healthy 50% increase over the year. When presented with the statement of profit or loss for the year, she was dismayed to note that profit had deteriorated significantly. In her anger, she accuses you of having made errors in the accounting since ‘such a silly situation could not possibly exist’.

Required

Explain how you would respond to Lana Ferdinand.

Answer 1

Having an increasing growth in cash flow is never an indication of profit. Cash flow is purely based on the inflow and outflow of cash. It can be through revenue from operations, sale of investments, issue of sales etc. So inflow of cash is not an indication of increased sales. Likewise cash outflow can be through expenses, investment in assets, redemption of shares etc. Increased/decreased cash flow never means decreased/increased growth in expense. So comparing cash flow with profit is not correct. Growth in cash flow only represents that inflow of cash is increased. Not profit