Question

It has been suggested that ‘cash is king’ and that users of financial information should pay more attention to information concerning its cash flows and balances than to its profits and other assets. It is argued that cash is more difficult to manipulate than profit and that cash flows are more important.”

1. Explain whether you agree with the suggestion that cash flows and balances are more difficult to manipulate than profit and non-cash assets. (Maximum word count: 150)

[8 marks]

2. Explain why it might be dangerous to concentrate on cash to the exclusion of profit when analysing a set of financial statements.

Answer 1

ANSWER:

(a)       Cash is exact, profits are calculated via concepts which permit various interpretations/judgments. Profit is a moving target. Cash balances can be boosted at year end quite easily by withdrawing payments, taking out loans, encouraging by incentives early debtor settlement etc.

(b)       Company needs cash flow and profit to survive. Concentration on increasing cash balances is bad policy as the money will not be earning unless it is invested somehow.