Cash Versus Profit as a Measure of Performance
In order to put in context the quality of cash flow information compared to the P&L it is first necessary to understand something of the history of the P&L, the assumptions that underpin its use and the areas in accounts that are vulnerable to manipulation by those seeking to bias their reporting of performance. Finally, this is contrasted with the information about performance disclosed in the cash flows.
HISTORY OF THE P&L
For centuries, profit has been the accepted measure of success in business, a good business being one that is consistently and highly profitable. The concept of profit (as opposed to loss) being that the business received more in income than it spent on costs in a particular measurement period.
In a cash business (a business where all the income is received as cash and all the costs are paid for in cash at the time of purchase) the cash surplus and the profit is the same amount. In the sixteenth and seventeenth centuries this simple approach to performance measurement was probably adequate for most businesses. In the eighteenth century the industrial revolution bought new problems and opportunities, one major innovation was the pooling of capital by investors to undertake larger and larger projects. First the canals and then the railways were constructed, to facilitate the movement of both raw materials and finished goods. At the same time factories came into being to exploit the economies of scale created ...