Question

In: Accounting

A company can show a significant loss on its income statement but yet have a very...

A company can show a significant loss on its income statement but yet have a very substantial positive cash flow. Assuming the reporting is accurate and honest, what implications does this have for the business, its shareholders, its employees, and society as a whole? Are there ethical issues to be considered, and if so what are they and how should the business proceed?

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Expert Solution

Significant loss in income statement and positive cash flow effect on business:- Cash flow is the net amount of cash and cash equivalents being transacted in and out of a company in a given period. If a company has positive cash flow, the company's liquid assets are increasing. Net income is the profit a company has earned, or the income that's remaining, after all expenses have been deducted. Net income is commonly referred to as to the bottom line since it sits at the bottom of the income statement. Sometimes company can have positive cash flow while reporting negative net income relate to each other.

Since net income is calculated by substracting the costs of doing business including expenses, taxes, depreciation, and interests on debt from total revenue. If net income is positive, the company is liquid and has a higher probability of paying off its debts, paying dividends to shareholders and paying its operating expenses.

Cash flow is reported on the cash flow statement, which shows where cash is being received and how cash is being spent. If a company has a positive cash flow, it means the company's liquid assets are increasing.

Overall, it states that although company has net loss but it has sufficient funds to spend and pay off its debts.

Significant loss in income statement and positive cash flow effect on Shareholders:-

As the net profit is negative, the company can not transfer funds to reserves. It will impact general reserves or other reserves but since the company has positive cash flows it can pay dividends to the shareholders. However it is all up to the company that if it wants to pay dividend or not but if it had paid dividends in past and want to maintain the same tradition, then it is advisable to pay off dividends to shareholders.

Significant loss in income statement and positive cash flow effect on Employees:-

Cash flow trends can be the ultimate measure and indicatorof success and/or failure of the company's performance. If cash flows are positive it does not impact the payment of salaries, bonus, commission etc. to the employees. If company also wants to issue ESOP, it can take such decision without much hindrances. So employees may not face genuine hindrances in receiving the bonuses or commissions in accordance of their performance.

Significant loss in income statement and positive cash flow effect on Society:-

The statements of a company is used by various users. These users can be suppliers, customers, potential investors, banks etc. If income statement shows net profit, it can adversely impact the company as many of the users make conclusions only on the basis of net profit i.e. how much the company is earning. However, other users like banks, investors, customers make several conclusions in the basis of many assumptions. They consider the company's capacity to repay back the money or any interest thereon. So in above case, it can be implied that company has capacity to pay back the money but revenues or gross earnings of company are on declining criteria.

Apart from above, ethical issues are also to be considered. There are some ethical issues that can arise and have to be taken into account. Such ethical issues can be:-

Create a value for all:- It states that cash flow and other statements showing net profit should be such that these statements provide the value to the users of statement. Every users has different purpose from the organisation and require different information according to his/her convenience. So, the business should proceed in this case by cash management and cash holding techniques should be developed on the basis of financial theories. These techniques should also be consistent with the goal of maximizing shareholders' wealth.

Mutual Management based on Trust:-

A good management is also required if a company has to improve in all perspectives. Above mentioned condition, although, is not so bad as company is in liquid state. But there is a lack of management as to find out which non-cash expenses has been charged more or whether the revenue is in declining state or what are the reasons behind such circumstances. This can happen if their is mutual management based on mutual trust.

Potential Conflict:-

As we already discussed earlier that each user of financial statement required different information, there can arise a conflict between different users. For example:- a bank will take into consideration that company is liquid enough and is able to repay its loans and interest thereon whereas a long term intended investor also pays attention to the net profit of company as if company remains in losses it wouldn't be able to generate funds which will be disadvantageous for company in long run. In such case financial policies should be made in interests of all stakeholders.


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