The W.T. Grant Company was the nation\'s largest retailer until it filed for ban

Question

The W.T. Grant Company was the nation's largest retailer until it filed for bankruptcy only one year after it had reported profits of over 20 million for more than ten consecutive years. Yet cash flow provided by operations started dipping several years earlier and remained negative until the company's collapse. a. what kind of items might account for such a divergence between net income and cash flow provided by operations? b. what information on the financial statements could have provided some warning of the company's failure?

Explanation / Answer

Profit and cash-flow are related financial measurements in accounting but they are not directly linked. Profit is a measure of an company's ongoing sustainability while cash-flow is a measure of the company's ability to pay its bills as they become due.

he cash-flow for a particular period is the closing cash balance arrived at after deducting the cash-out (paid) from the cash-in (received). Profit on the other hand, is the amount that remains after deducting from the revenue earned, the expenses incurred in earning that revenue.

Now in accounting, something is only expensed when the economic value is completely used up. But in any given period, an enterprise may have spent far more in cash than was actually expensed by the accounting system. i.e. the company buys 100 x $10 reams of paper to take advantage of a supplier's discount but only uses 50 reams during the financial reporting period. So while the company outlays $1,000 in cash, it only expenses (uses up) $500 in the financial reporting period.

Similarly in revenue, a company may make sales revenue of $1,000 for the same financial reporting period but if 50% of those sales were made to customers who used their company credit accounts (accounts receivable), then the company would only receive $500 in cash in this financial reporting period. The other $500 would be owed to the company by the customers who will pay the amount in a future reporting period.

Using this simple and rather restricted example, you can see how a company can make profit but still be cash-flow negative:

The reasons for difference between Net profit and cash flow:

The below are certain items that contribute for difference between cash flow and profits of the enterprise. The following items consume cash regardless of profit and thereby results in cash crunch; in spite of having adequate profits

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