“Profit is an illusion. Cash is an ultimate. Cash is king.”
For many reasons, this quote particularly struck me from the Corporate Financial Accounting class. In this writeup, I’ll be explaining my reasons and perspectives to better understand the quote.
In theory, business profit is calculated by subtracting total expenses from total revenue. Simple right? Not so. The composition of total revenue is quite noteworthy and interesting. Using an accrual basis, items sent to customers on credit also add up to revenue. Also, all transactions are assumed to be on credit except stated otherwise. So, usually, a chunk of documented revenue are not actualized in cash. Hence, documented profit does not translate to liquid cash.
This study puts a lot of things into perspective. See a perspective on wealth and wealth accumulation. If a company’s declared profit can be described as an illusion, it’s safe to follow the slope to investors’ dividends, their acclaimed profits and wealth in general. Certain declared dividends may not be able to be cashed because the profit declared is not cash. So, we can say wealth is also an illusion. People are wealthy by profit declared not cashed. The slope goes on to gross or net worth calculation, wealth transfer and declaration.
Also, Growing up, a popular Ijebu slang shabbily translated to English was “follow the money you see, not the money they see”. It can be explained as an advice to only invest your resources in what you can ascertain its reality, not what you are not sure of its actualization regardless of how promising it appears. People are more likely to respect who has money at hand right now, than someone that’s promised money, even when the promised amount is reasonably higher than the money at hand. It’s close to the saying that “a bird in hand is worth two in the bush”.
Additionally, it is safe to say the quote goes in line with the stereotype around investment in things like stock or company equity over traditional businesses where cash and cash flow is seen and felt directly. Traditional businesses deal directly with cash. So owners, at any point in time, are in control of their money and cash flow. They choose to buy and spend at will. He is King. In investments like company stock, however, the investor may not have direct influence over his money and how it is being used. Even in situations where he can exit at will and at any time, most investors do not do that. The optimism of a better profit margin keeps the investment in the company’s hands for long. With the quote, I fully understand the stereotype and how it applies to the real world.
Finally, for businesses, cash is king. As much as it is crucial to have profit, cash keeps a business running. Put to perspective a business that declares 90% of profit as non-cash. They’re left with 10% profit to stay in business for another session. Even though the business is profitable, its sustainability is very questionable. So it is always crucial for businesspersons to remember that “Profit is an illusion and Cash is king.”