Originally Posted by
T-Vasis
Net profit has its merits - it is a powerful measure for thinking about how shareholders have been doing - but it has its problems. First, it treats cash and noncash expenses symmetrically. Second, net profit also subtracts interest payments, which make it hard to compare companies that finance themselves in different ways even though their operations could be quite similar. Finally, and most importantly - many managerial decisions are involved in calculating profit. Accounting asks managers to make decisions in order to smooth returns, as accountants consider that to be more consistent with reality. This allows managers to manipulate profits to their advantage. In contrast, cash is cash, and arguably, is not susceptible to similar managerial discretion.
Amazon is a good example. In 2014 their net profit was negative $241m. EBIT was $178m. $419m was tax, interest and currency adjustments. EBITDA was $4.9b. $4.7b was depreciation and amortization. Amazon generated a lot of cash but had losses according to profitability measures.
Cash is a better measure of economic returns relative to profits. The emphasis on cash can explain why companies that generate profits but no cash, might be unsustainable and why companies that generate no profits but lots of cash might be valuable. Second - cash that is earned today is more valuable than cash earned tomorrow because of the opportunity cost of capital. Ignoring the opportunity cost can lead to value destruction or value transfers. All value comes from future cash flows and making positive net present value decisions is the hallmark of a good steward of capital and manager.
I do hope you’ve been to or teach at the Harvard Business School, T-V, because that’s one of the more impressive collections of meaningless financial rhetoric I’ve read in quite a while.