CAN WE TRUST ACCOUNTING RESULT AND CASH-FLOW IN APRECIATING FINANCIAL PERFORMANCE?

Abstract

Is profit an indicator that reflects the real performance of the economic entity? Or is it rather a benchmark for uninitiated users who do not know the artificial effects of policies, options and accounting estimates on this sensitive indicator? The vulnerability of the accounting result makes us focus on the objective nature of cash flow, which is a more modern and tangible measure of performance, eliminating the effects of using different accounting treatments for the same transactions. Corroborated, the two coordinates - the accounting result and the cash flow, and more specifically those related to the operating activity - would give a better appreciation of performance. What should we understand when these indicators contradict each other? Is that possible? The case outlined in this paper demonstrates that the answer is yes. But why does this happen and how do we appreciate the performance in this case? The present paper begins by presenting some beliefs that profit is an important indicator of financial performance. These are to be combated by presenting profit margins as an indicator of financial performance, the main or the disadvantage being its subjective character. Subjectivity does not apply to cash-flow, which leads us to say that the cash-flow reflects more objectively and more accurately the financial performance of the economic entity. Further, we will analyze the two indicators in parallel and comparatively, explaining the discrepancy that may arise between them and especially the situation where the profit is positive and cash-flow is negative. Our research is both empirical and theoretical. The results of this research point out to shareholders that profits can be misleading and recomend them to make a minimum simple comparison between proft and cash-flow, between operating profits and cash-flow from operations before they risk making decisions. Increased attention should certainly be given to the situation where there is a discrepancy between the two indicators, because according to some opinions it may even be a sign of the use of creative accounting, and practice has put us, not least, in the face of bankruptcy companies with huge profits.

Keywords

• financial performance; profit; cash flow; operating activity; shareholders; creative accounting.