Question

If managers and investors find cash flow more important than accounting profit, why do we still require firms to report accounting profit?  

Answer 1

Accounting profit is not the ultimate and true measure of a companies performance . Hence if we observe any financial statement under what ever regulation we can see one important statement called the cash flow statement . This clearly indicates three items cash flows from financing investing and operating activities.

For a business to function they need cash . Cash is used to run business for day to day activities.

- Employees need monthly compensation

- Factory labour need daily wages

- Supliers need payments

- Other general expenses should be paid in cash itself

So most of the managers need to check if the company is able to generate cash or not . Investors also need to check the cash profit also .

Generally cash profit is nothing but the accounting profit reduced with the non cash items.

Then whu do we include these non cash items in the accounting profit.

Let me give you a example-

You buy a machine and you incur cash . You are capitalizing the machine . That means you are not charging the machine as an expense inorder to get accounting profit. Now you start charging depreciation which is a non cash expenditure. When you buy machine it is indirectly generating economic benefits to us but we are using it in the process, that why we also recognise expense of depreciation to find out true accounting profit.

Similarly we book accrued income and also expense. Even though we do not pay for it but it should be paid/Recieved in the current year. Hence we should include.

This is the reason why we include non cash items in our profit and loss account also

Other reasons which include tax calculation, government regulations etc also require an entity to report the accounting profit.