7 Reasons Why GOOD Businesses, go BAD - Reason#4

Value Profits over Cash flow

The primary goal of most businesses is profit maximization i.e. increasing its bottom-line. As a result, the majority of decisions within the business will be evaluated in light of overall profits. Profit maximization focuses on the short-term earnings of the business however, making it the main strategy can be damaging over time (Short-termism). For example, a company seeking to increase profits may take on high risk investments which could endanger future returns available to its shareholders. As a consequence, risk-averse shareholders may sell causing a negative impact on share prices.

Although profitability is the traditional approach, its sole reliance can have the following drawbacks:

1. It ignores cash-flow which gives a more accurate view of the business' financial health.

2. Investors value cash-flow as oppose to paper-figures

3. Profits can be manipulated e.g. cutting discretionary expenses can produce a fake profit boost.

4. Ignores intangible benefits e.g. quality, image,etc

In conclusion: Profit is an indication of the business' financial position however, If there is no cash to keep the business operating on a day-to-day basis, there will eventually be no profits to report.

Tune in next week for Reason#5 of the series '7 Reasons Why GOOD Businesses, go BAD'