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:
It ignores cash-flow which gives a more accurate view of the business' financial health.
Investors value cash-flow as oppose to paper-figures
Profits can be manipulated e.g. cutting discretionary expenses can produce a fake profit boost.
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'
BUSINESS $ENSE: the Idiot's guide to growing a sustainable business | by Paulette Lightbourne