Economic Observer, by Chen Shimin and Huang Xiayan.
Companies always face various uncertainties and challenges from unexpected events during their development.
In 2023, thousands of companies closed down or went bankrupt, including star enterprises and unicorn companies.
The collapse of a company is a complex process influenced by multiple factors, and the exhaustion of cash flow is often the last straw that breaks the camel's back.
WM Motor, a new force in the car manufacturing industry, once on par with "Weilai, Xiaopeng, and Li Auto," has raised over 35 billion yuan in public financing since its establishment.
However, starting from 2022, it fell into a predicament of arrears in wages, layoffs, and pay cuts due to the breakage of the capital chain, and has now entered a reorganization process with a debt of up to 20.367 billion yuan.
GAC Aion also faced a cash crunch and production difficulties, suspending production in February this year, and entered a pre-reorganization process in August.
And Royole Technology, a "unicorn" once valued at over 50 billion yuan, is also heading towards bankruptcy due to cash flow issues.
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These cases all warn of the importance of "cash is king," but truly understanding "cash is king" is not so simple.
The Origin and Evolution of "Cash is King" The concept of "cash is king" can be traced back to the 1890s in George N. McLean's book "How to Do Business, or the Secrets of Success in Retailing."
McLean listed "avoid credit, remember cash is king, credit is a slave" as one of the twelve business maxims.
After the global stock market crash in 1987, Pehr G. Gyllenhammar, the then CEO of Volvo Group, once again emphasized "cash is king," making this concept widely popular in the financial and business fields.
Since then, Warren Buffett has also repeatedly emphasized the importance of cash, further promoting the popularity of this concept.
Currently, with the increasingly complex economic situation, the operational risks faced by companies have risen significantly.
Cash, as an important buffer against uncertainty, has become more prominent, and the media and business circles have repeatedly emphasized the importance of "cash is king."
However, many interpretations oversimplify this concept and there are many misunderstandings.
For example, many people mistakenly believe that as long as they hold enough cash, it is "cash is king," and mistakenly believe that the company's management's focus on cash is more important than profits, and so on.
In short, the simplified concept of "cash is king" ignores its complexity and strategic nature.
To truly understand "cash is king," it is necessary to clarify several key concepts.
First, it is necessary to clarify whether "cash" refers to the cash balance or cash flow.
If the focus is on cash flow, it is also necessary to distinguish whether the cash flow is generated by operating activities, investing activities, or financing activities.
Secondly, among the three major financial statements of a company, although the importance of the cash flow statement cannot be ignored, does "cash is king" mean that the cash flow statement is the most important financial statement?
Interpreting "Cash is King" First, we need to clarify whether "cash" refers to the cash balance or cash flow.
The cash balance is the amount of cash and equivalents held by a company at a specific point in time.
Although the cash balance is very important for assessing the company's immediate payment ability and short-term financial security, it cannot fully reflect the company's long-term financial health like cash flow.
Cash flow measures the company's ability to obtain and use cash through operating activities, investing activities, and financing activities within a certain period.
This is a dynamic indicator that reflects the company's financial health and liquidity.
If a company can continuously generate positive cash flow, it indicates that the company has the ability to sustain itself and develop, pay off debts, make investments, return to shareholders, and cope with sudden 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 the cash balance.
And 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 company's daily operations, including cash received from selling goods and providing services, as well as cash paid for raw materials, employee wages, and other operating costs.
This concept shows the company's basic profitability and operational efficiency from the perspective of cash receipt and payment, and is the core indicator for judging whether the company 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 potential for future growth.
Cash flow from financing activities covers the sources of financing for the company, including debt and equity financing, repayment of debts, payment of interest and dividends, and cash flow of financing activities, showing 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 hematopoietic function is crucial for human survival, cash flow from operating activities is the foundation for the company's continuous operation and development.
A healthy cash flow from operating activities can ensure that the company can sustain itself and develop without relying on external financing, and improve the company's ability to resist market fluctuations.
A stable cash flow from operating activities also provides more options and flexibility for investment and financing activities, enabling the company to conduct 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 exploring in depth.
First, we need to understand that the formation of operating cash flow is mainly influenced by two categories of factors: the income statement items and the balance sheet items.
Profitability is the most important factor affecting operating cash flow.
Specifically, increasing sales revenue can increase the inflow of operating cash flow, and controlling costs and expenses can effectively improve the situation of cash outflow.
Depreciation and amortization are non-cash expenses, which reduce net profit but do not affect cash flow, but instead make the 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 from operating activities reached 24.879 billion yuan, mainly because depreciation and amortization were as high as 18.726 billion yuan; and the high depreciation costs mean that the company may have a significant investment expenditure 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 the occupation of funds; accelerating the recovery of accounts receivable can increase the inflow of cash; and managing accounts payable reasonably can balance cash outflow.
For example, in the first half of 2024, Sany Heavy Industry's net profit was 3.648 billion yuan, a year-on-year increase of 4.06%; the net cash flow generated from operating activities reached 8.438 billion yuan, a significant year-on-year increase of 2204.61%, mainly due to the increase in sales repayments and the reduction in procurement payments.
Although we usually think that a higher operating cash flow is a positive signal of financial health, this view is not absolute.
For capital-intensive companies, a decline in sales may lead to a significant decrease in profitability, but due to the existence of high depreciation, the operating cash flow may still be far higher than net profit.
However, this cash flow is not sustainable, the actual profitability is declining, and the large amount of investment required for equipment updates in the future may still put the company in financial difficulties.
Similarly, managing current assets and current liabilities through abnormal means, such as delaying payments or accelerating repayments, although it can improve cash flow in the short term, this practice that deviates from the conventional business model is also unsustainable and may lead to long-term financial pressure or operational instability.
The ideal operating cash flow should be consistent with the company's profitability.
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 company's cash flow is consistent with the profit level, reflecting a higher quality of profitability.
However, for companies with a higher proportion of depreciation and amortization, this ratio may exceed 1.
In summary, a healthy and sustainable cash flow from operating activities should come from the company's robust core business activities.
Only with strong profitability and effective asset-liability management strategies can the company maintain high-quality cash flow from operating activities.
If the company's profitability is insufficient, even if it temporarily increases cash flow through unconventional measures, this improvement is difficult to sustain.
In other words, a truly healthy cash flow from operating activities must be based on continuous profitability, and not just rely on short-term cash management strategies.
Managing Cash Balance Determining the "ideal" cash balance is a complex but important task.
The ideal cash balance should not only meet the needs of the company's daily operations but also consider the cost and opportunity of investment opportunities and external financing.
The cash needed for company operations usually includes cash needs in daily business activities, such as the purchase of raw materials, payment of employee wages, rental expenses, taxes, and other operating expenses.
Determining this part of the cash needs can use different methods.
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 recover sales, and improve the efficiency of capital use by optimizing inventory management, accelerating the recovery of accounts receivable, and reasonably adjusting the payment of accounts payable.
Managers can also identify seasonal fluctuations and long-term trends in cash needs through budgeting and historical data analysis.
The ideal cash balance should not only meet the needs of daily operations but also fully consider potential investment opportunities, such as expansion, new product development, or mergers and acquisitions.
Companies need to weigh the pros and cons of holding cash and making investments, analyze the expected returns of different investment channels, and conduct detailed financial assessments of potential investments, including expected rates of return, potential risks, and investment time frames, to decide the most appropriate way to use funds.Additionally, different financing methods bring different costs and opportunities, and appropriate choices can significantly enhance a company's financial efficiency and market competitiveness.
The costs of external financing mainly include interest expenses and potential equity dilution.
For example, in August 2024, the market quotation rate (LPR) for one-year loans in our country was 3.35%, and for loans with a term of more than five years, it 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 complex, relying on market valuation and investor expectations.
Market interest rates, investor sentiment, and credit market conditions are key factors affecting the cost and feasibility of financing.
Companies need to choose the most suitable financing strategy based on their financial situation and market conditions to optimize capital structure and reduce financing costs.
Companies 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 phase may rely more on equity financing to obtain the necessary development funds.
Companies have different cash balance needs at different stages of development and must carry out corresponding financial management and planning according to the characteristics of each stage.
Companies usually face higher uncertainty at the start-up stage, so they need higher cash reserves to support business establishment, product development, and market development.
At the same time, startups may face unstable income or tight cash flow issues, and higher cash reserves can also help alleviate financial pressure and ensure the survival and development of the company in the early stage.
As the company enters the growth stage, the increase in market expansion and investment opportunities requires more refined cash management.
At this stage, companies need a large amount 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 liquidity to support the company's rapid expansion.
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, companies still need to maintain a certain liquidity to cope with market fluctuations, technological updates, and possible merger and acquisition opportunities.
At this stage, companies should make moderate innovative investments on a solid basis, while maintaining sensitivity to market changes to cope with possible external challenges.
In the recession stage, companies may face issues such as declining market share and weakened profitability.
At this time, the focus of cash management is to maintain operations or restructure the business by optimizing costs and strict cash flow management.
Companies need to cut unnecessary expenses, concentrate resources to support core businesses, and look for opportunities to transform or adjust strategies to regain market competitiveness.
"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 corporate cash, the income statement shows the company's profitability, and the balance sheet reflects the company's financial structure.
The three complement each other and provide comprehensive information support for corporate decision-making.
Therefore, only by accurately understanding these three statements and effectively integrating them can the concept of "cash is king" be truly implemented, ensuring that the company maintains good business performance and a solid financial condition in economic fluctuations and market uncertainty.