Question

Profitability and cash flow are not interchangeable concepts. A company's profitability does not always indicate it is generating cash flow. In your own words, differentiate profit and cash flow. Provide an example and discuss a situation where profit and cash flow are at odds. Participate further by responding to peers, indicating whether you agree or disagree with their assessment and differentiation of profit and cash flow. Provide a detailed explanation.

Answer 1

Profitability and cash flows are different concepts. Profitability takes into account expenses that may have incurred during the period, but the business (or firm) didn't need to pay the cash (there are no cash outflows). Depreciation & amortization costs are the simplest examples of non-cash expenses. On the other hand, cash flows adds back these non-cash expenses, and also takes into account any capital expenditures that may have taken place during the period, or any change in net working capital during the period. Please note that capital expenditures are generally not expensed, but capitalized over the period of life of the equipment (or machine). Hence, there is going to be huge cash outflow (inflow) on purchase (sale) of a PPE in the beginning, but no cash outflow (inflow) later. However, capitalized costs goes into profitability and hence, expenses are distributed throughout the course of life of equipment (machine). Similarly, investments in stocks are not expensed, but they are cash outflows.

A good example where profitability and cash flows can be odds are capital-intensive industries such as aviation, telecom, infrastructure etc. where huge capital expenditures (or sale) are made every year.