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chen shimin and huang xiayan/text in the process of development, enterprises always need to face various uncertainties and unexpected challenges. in 2023, thousands of companies closed down or went bankrupt, including many star companies and unicorn companies. the bankruptcy of a company is a complex process under the influence of multiple factors, and the depletion of cash flow is often the last straw that breaks the camel's back.

wm motor, a new car-making force that once stood shoulder to shoulder with nio, has raised more than 35 billion yuan in public financing since its establishment. however, since 2022, it has been in a predicament of withholding employee wages, laying off employees and cutting salaries due to a broken capital chain. it has now entered the reorganization process with a debt of 20.367 billion yuan. hiphi also stopped production in february this year due to tight cash flow and production difficulties, and entered the pre-reorganization process in august. royole technology, a "unicorn" once valued at more than 50 billion yuan, is also heading towards bankruptcy due to cash flow problems.

these cases all warn us of the importance of “cash is king”, but truly understanding “cash is king” is not that simple.

the past and present of “cash is king”

the concept of "cash is king" can be traced back to george n. mclean's book "how to do business, or the secret of retailer's success" in 1890. mclean listed "avoid credit, remember cash is king, credit is slave" as one of the twelve business mottos.

after the global stock market crash in 1987, pehr g. gyllenhammar, then ceo of volvo group, once again emphasized that "cash is king", making this concept widely popular in the financial and business fields.warren buffett(warren buffett) has also repeatedly emphasized the importance of cash, further promoting the popularization of this concept.

at present, as the economic situation becomes increasingly complex, the operating risks faced by enterprises have increased significantly. as an important buffer to deal with uncertainty, cash has become more prominent, and the media and the business community have reiterated the importance of "cash is king".

however, many interpretations simplify this concept and contain many misunderstandings. for example, many people mistakenly believe that as long as there is enough cash, "cash is king" and that the focus on cash in corporate management is more important than profit. in short, the simplified "cash is king" concept ignores the complexity and strategic nature behind it.

to truly understand “cash is king”, we need to clarify several key concepts. first, we need to clarify whether “cash” refers to cash balance or cash flow. if we are focusing on cash flow, we also need to distinguish whether it is cash flow generated by operating activities, investment activities or financing activities. secondly, in the three major financial statements of an enterprise, althoughcash flow statementthe importance of cash flow statement cannot be ignored, but does “cash is king” mean that the cash flow statement is the most important financial statement?

explaining “cash is king”

first, we need to clarify whether "cash" refers to cash balance or cash flow.

cash balance is the amount of cash and equivalents a business holds at a specific point in time. while cash balance is important for assessing a business's immediate payment ability and short-term financial security, it does not reflect the long-term financial health of a business as comprehensively as cash flow.

cash flow measures the ability of an enterprise to obtain and use cash through operating activities, investment activities and financing activities in a certain period of time. it is a dynamic indicator that reflects the financial health and liquidity of an enterprise. if an enterprise can continuously generate positive cash flow, it means that the enterprise has the ability to sustain and develop itself, pay debts, make investments, return to shareholders, and cope with unexpected economic challenges.

therefore, when we talk about "cash is king", we should focus on the management and maintenance of cash flow rather than simply focusing on cash balances.

cash flow is divided into three parts: cash flow from operating activities, cash flow from investing activities and cash flow from financing activities.

cash flow from operating activities is the cash flow generated by the daily operations of an enterprise, including cash received from the sale of goods and services provided, as well as cash paid for raw materials, employee wages and other operating costs. this concept shows the basic profitability and operating efficiency of an enterprise from the perspective of cash receipts and payments, and is a core indicator for judging whether an enterprise can maintain long-term operations and growth.

cash flow from investing activities involves the outflow and inflow of funds on long-term assets such as fixed assets and external equity investments, reflecting the company's long-term strategic layout and future growth potential.

cash flow from financing activities covers the company's sources of financing, including debt and equity financing, debt repayment, interest and dividend payments, and shows how the company balances its capital structure and funding needs through financing activities.

among these three, cash flow from operating activities is at the core. just as hematopoiesis is essential for human survival, cash flow from operating activities is the basis for the continued operation and development of an enterprise.

healthy operating cash flow can ensure that the enterprise can maintain and develop itself without relying on external financing, and improve the enterprise's ability to withstand market fluctuations. stable operating cash flow also provides more options and flexibility for investment and financing activities, allowing enterprises to carry out investment activities and capital allocation under more favorable conditions.

managing cash flow from operating activities

what are the determinants of cash flow from operating activities? is the higher the cash flow from operating activities, the better? these questions are worth our in-depth discussion.

first of all, we need to understand that the formation of operating cash flow is mainly affected by two major factors: income statement items and balance sheet items.

profitability is the most important factor affecting operating cash flow. specifically, increasing sales revenue can increase operating cash inflows, while controlling costs and expenses can effectively improve cash outflows. depreciation and amortization are non-cash expenses that will reduce net profit, but do not affect cash flow. on the contrary, they will make operating cash flow exceed net profit.

for example, in the first half of 2024, boe's net profit was only 1.771 billion yuan, but the net cash flow generated by its operating activities reached 24.879 billion yuan, mainly because depreciation and amortization were as high as 18.726 billion yuan; and the high depreciation expenses mean that the company may have relatively large investment expenditures in the future.

in addition to profitability, inventory, accounts receivable and accounts payable in the balance sheet also have a significant impact on cash flow. reducing inventory can reduce capital occupation; speeding up the collection of accounts receivable can increase cash inflow; and reasonable management of accounts payable can balance cash outflow.

for example, in the first half of 2024,sany heavy industrynet profit was 3.648 billion yuan, a year-on-year increase of 4.06%; net cash flow from operating activities reached 8.438 billion yuan, a significant year-on-year increase of 2204.61%, mainly due to the increase in sales collection and the decrease in procurement payments.

while we generally consider higher operating cash flow to be a positive sign of financial health, this view is not absolute.

for asset-heavy companies, a decline in sales may lead to a sharp drop in profits, but due to the existence of high depreciation, cash flow from operating activities may still be much higher than net profit. however, this cash flow is not sustainable, actual profitability is declining, and the large amount of investment required for future equipment updates may still put the company into financial difficulties.

similarly, managing current assets and liabilities in an unnatural way, such as delaying payments or accelerating collections, may improve cash flow in the short term. however, this deviation from the normal business model is also unsustainable and may lead to long-term financial pressure or operational instability.

ideally, operating cash flow should match the profitability of the enterprise. one of the commonly used indicators to measure this matching degree is the ratio of cash flow from operating activities to net profit. when this ratio fluctuates around 1, it usually indicates that the cash flow of the enterprise is consistent with the profit level, reflecting a high profit quality. however, for enterprises with a high depreciation and amortization ratio, this ratio may exceed 1.

in summary, a healthy and sustainable operating cash flow should come from the company's robust core business activities. only with the support of strong profitability and effective asset-liability management strategies can a company maintain high-quality operating cash flow.

if a company's profitability is insufficient, even if it temporarily improves cash flow through unconventional measures, this improvement will be difficult to sustain. in other words, truly healthy operating cash flow must be based on sustained profitability, not just short-term cash management strategies.

managing cash balances

determining the "ideal" cash balance is a complex but important task. the ideal cash balance must not only meet the needs of the company's daily operations, but also take into account the costs and opportunities of investment opportunities and external financing.

the cash required for a company's operations usually includes cash requirements for daily business activities, such as raw material purchases, employee salary payments, rental costs, taxes and other operating expenses. there are different ways to determine this part of cash requirements. for example, managers can use the cash conversion cycle (ccc) to measure the number of days it takes for a company to pay suppliers and collect sales proceeds, and shorten this cycle and improve the efficiency of capital use by optimizing inventory management, accelerating the collection of accounts receivable and reasonably adjusting accounts payable payments. managers can also identify seasonal fluctuations and long-term trends in cash requirements through budget and historical data analysis.

the ideal cash balance should not only meet daily operational needs, but also take into account potential investment opportunities, such as capacity expansion, new product development, or mergers and acquisitions. companies need to weigh the pros and cons of holding cash and investing, analyze the expected returns of different investment channels, and conduct a detailed financial assessment of potential investments, including expected rates of return, potential risks, and investment time frames, in order to determine the most appropriate way to use funds.

in addition, different financing methods bring different costs and opportunities. the appropriate choice can significantly improve the financial efficiency and market competitiveness of enterprises. the cost of external financing mainly includes interest expenses and potential equity dilution.

for example, in august 2024, my country's one-year loan market benchmark rate (lpr) was 3.35%, and the lpr for more than five years was 3.85%. the cost of corporate bond issuance depends on credit ratings and market interest rates, while the cost of equity financing is more complicated and depends on market valuations and investor expectations. market interest rates, investor sentiment and credit market conditions are key factors affecting financing costs and feasibility.

enterprises need to choose the most suitable financing strategy according to their own financial situation and market conditions to optimize capital structure and reduce financing costs. enterprises with stable cash flow and high credit ratings may prefer to use debt financing to maintain equity control and reduce financing costs. startups in the rapid growth stage may rely more on equity financing to obtain necessary development funds.

enterprises have different demands for cash balances at different stages of development, and must carry out corresponding financial management and planning based on the characteristics of each stage.

companies usually face high uncertainty when they are first established, so they need higher cash reserves to support business establishment, product development and market expansion. at the same time, start-ups may face problems such as unstable income or tight cash flow. higher cash reserves can also help alleviate financial pressure and ensure the survival and development of companies in the early stages.

as companies enter the growth stage, market expansion and increased investment opportunities require companies to conduct more sophisticated cash management. at this stage, companies need a lot of funds for expansion, such as increasing production capacity, expanding markets, and developing new products. the focus of cash management is to ensure efficient investment of funds while maintaining a certain level of liquidity to support the rapid expansion of the company.

after entering the mature stage, the company's cash flow is usually more stable, the business model is relatively mature, and the market share tends to be stable. however, the company still needs to maintain a certain liquidity to cope with market fluctuations, technological updates, and possible m&a opportunities. at this stage, the company should make moderate innovation investments on a solid basis, while maintaining a keen sense of market changes to cope with possible external challenges.

in the recession stage, companies may face problems such as declining market share and weakened profitability. at this time, the focus of cash management is to maintain operations or restructure the business through cost optimization and strict cash flow management. companies need to cut non-essential expenses, focus resources on supporting core businesses, and look for opportunities to transform or adjust strategies to regain market competitiveness.

why king

"cash is king" is not just a slogan, it also reflects the core role of cash management, including cash flow and cash balance management, in business operations.

but this does not mean that the income statement and balance sheet can be ignored. on the contrary, cash management must be closely integrated with the income statement and balance sheet.

the cash flow statement reveals the actual flow of cash in the enterprise, the income statement shows the profitability of the enterprise, and the balance sheet reflects the financial structure of the enterprise. these three complement each other and provide comprehensive information support for corporate decision-making.

therefore, only by accurately understanding these three statements and combining them effectively can we truly implement the concept of "cash is king" and ensure that companies maintain good operating performance and sound financial conditions amid economic fluctuations and market uncertainties.

(chen shimin is professor of accounting and vice dean of academic affairs (case center) at ceibs, and huang xiayan is a research fellow at ceibs case center)