15 November 2015

Cash is King

The truest picture of how well a company is doing comes from understanding not just the profit and loss statement and the balance sheet, but how these describe what is happening to cash in the company.

by John Royden

Head of Research


But to get a firm picture of what is happening to cash you need to reverse out non cash entries.

Here’s an example of a company’s profit and loss statement:

cash is king

It looks as if Fudge Company Ltd is doing well; profit in 2013 of £21.7m was up on profit of £19.7m in 2012. However, a closer inspection of the statement shows that this might well be just because the directors changed the depreciation policy.

Depreciation is the accountants’ way of moving the purchase cost of a machine into the profit and loss statement over time. Usually it is something like 10% of the cost of the machine every year for ten years.

If the directors of Fudge Company Ltd saw cash costs go up from £50m to £60m they could change the depreciation policy to write their machines off over twenty years, rather than just ten. This would halve the depreciation charge from £25m to £12.5m and result in a higher profit in the Report and Accounts. In fact, Fudge Company Ltd is doing less well as it only made £40m of pre-tax cash profit, or EBITDA, rather than £50m in the year 2012.

EBITDA stands for Earnings Before Interest Tax Depreciation and Amortisation and means cash profit before tax.


Related articles

You probably sort of know how index linked gilts, or “linkers,” work. The redemption value is linked to the change in the retail price index, or RPI, that takes place over the life of the gilt. 

Another word for duration could be the average life of a bond. Most bonds pay annual or semi-annual coupons and have a redemption date. So whilst a bond maturing in three years and with a £5 annual…

The most commonly used multiplier model is the price- to-earnings (P/E) multiple. Very simply, a company with a high P/E may be considered overvalued when measured relative to peers. There are many…