Disadvantages of Cash Flow Generation
Some disadvatnages may exist when a company focuses solely on cash flow generation.
Companies often have an interest in making profits and generating cash for future business operations. While both activities typically have a close relationship, one may dominate the other. While cash is king in business, focusing solely on cash flow generation may be a disadvantage for a business. These drawbacks often require the business to balance its operations.
Cash flow generation may lead to lower sales. Selling goods and services involve cash receipts or allowing customers to pay over time, using an accounts receivable setup. Accounts receivable allow customers to pay outstanding balances off over time, such as 30 or 60 days. An issue with accounts receivable is the delayed cash collections. Cash flow decreases as accounts receivable increases. Companies that focus more on generating cash flow by selling goods and services for cash can have a myopic outlook in business.
Cash flow accounting may increase workloads in accounting. Accountants must record and report activities based on cash rather than traditional accrual accounting. In some cases, accountants may need to keep separate ledgers or accounts for measuring cash flow movement. The cash budget is an additional tool a company uses to track cash flow generation. This budget is outside of all the other budgets a company may also use in normal operations. Matching the cash budget with others is an extra activity for accountants.
The statement of cash flows is an additional statement accountants prepare at month end. This statement takes information from the company’s income statement and balance sheet. In short, the statement of cash flows transforms a company’s accrual-based income statement into a cash basis report. The statement of cash flows is often difficult to prepare as it takes standard accounting information and reverses its effect for cash flow purposes. The additional reporting must also meet generally accepted accounting principles and other requirements.
Most businesses use a combination of standard accounting and cash flow generation tools in business. Accountants can develop accounting policies that allow for both profit maximization and cash flow generating activities. Though the same ledgers, journals and schedules include information for these activities, the preparation and use of the information is the difference. Other times, a company will use a financial analysis employee in addition to standard accounting positions to measure cash flow generation.