Explain how a company can be reporting accounting profits but financial analysts could conclude that management...

Explain how a company can be reporting accounting profits but financial analysts could conclude that management is not adding economic value—in fact is reducing the value of the company. What would that imply about the firm’s IRR and ROE?

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The accountant uses financial information to locate the past data i.e the past transactions of the company.

Whereas financial manager uses financial information for projecting the future financial data using the past data.

For an Accountant the Accrual principal matters, Not the actual cash inflow or Outflow.

Whereas for a financial manager actual cash inflow or outflow matters, he will be looking at the cash flow statement for it.

Actual cash flow data is important for estimating working capital needs and management, liquidity management and Assets management.

Which are very crucial for the smooth functioning of the business.

A scenario where the company can be reporting accounting profits but financial analysts could conclude that management is not adding economic value—in fact, is reducing the value of the company is when:

A company has a lot of Accounts receivable balance,

As per accrual principal & Matching principal of Accounts its sales and profit.

But as per Financial Manager, there is no actual cash inflow, in fact, this increasing the working capital required and thus increasing the stress on the company's balance sheet.

The liquidity of the company is also reduced.

It destroys the economic value of the company.

The IRR is reduced as it is based on Cashflows.

But ROE is also reduced.

jeff jeffy answered 1 year ago

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