Whether in corporate operations or personal financial management, "cash is king" is a well-known and important financial concept, especially in an economic environment that is declining or showing uncertainty, it seems to be an important guideline for enhancing risk resistance. What does "cash is king" really mean? How can it truly be implemented in the business activities of companies? Professor Chen Shimin, a professor of accounting at China Europe International Business School, analyzes the meaning behind "cash is king" and points out that a truly healthy operating cash flow must be based on continuous profitability, not just relying on short-term cash management strategies.
Enterprises always need to face various uncertainties and challenges of emergencies during their development. In 2023, thousands of companies closed or went bankrupt, including star companies and unicorn companies. The bankruptcy of a company is a complex process influenced by many factors, and the exhaustion of cash flow is often the last straw that breaks the company.
WM Motor, a new force in car manufacturing that once stood shoulder to shoulder with "NIO, XPeng, and Li Auto", has raised more than 35 billion yuan in public financing since its establishment, but has fallen into a predicament of arrears of employee wages and layoffs and salary reductions since 2022 due to the breakage of the capital chain, and has now entered the reorganization process, with a debt of up to 20.367 billion yuan. HiPhi Motors also suspended production in February this year due to tight cash flow and production difficulties, and entered the pre-reorganization process in August. And Royole Technology, a "unicorn" once valued at more than 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.
01
The past and present 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 Secret of Success in Retail Merchandizing", where McLean listed "avoid credit, remember that cash is king, credit is a slave" as one of the twelve business mottos.
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.
At present, with the global economic situation becoming increasingly complex, the operating risks faced by enterprises have significantly increased. As an important buffer against uncertainty, the status of cash 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, mistakenly believing that as long as there is enough cash, it is "cash is king", mistakenly believing that the attention to cash in corporate management is more important than profit, and so on. In short, the oversimplified concept of "cash is king" ignores its complexity and strategy behind it.To truly comprehend the phrase "cash is king," it is essential to clarify several key concepts. First, one must determine whether "cash" refers to cash balances or cash flow. If it is cash flow, it is also necessary to distinguish whether it is generated from operating activities, investing activities, or financing activities. Secondly, among the three major financial statements of a company, while the importance of the cash flow statement cannot be overlooked, does "cash is king" imply that the cash flow statement is the most important financial statement?
02
Interpreting "Cash is King"
It is crucial to first clarify whether "cash" refers to cash balances or cash flow.
Cash balance refers to the amount of cash and cash equivalents a company holds at a specific point in time. Although the cash balance is important for assessing a company's immediate payment ability and short-term financial security, it does not provide a comprehensive reflection of the company's long-term financial condition like cash flow does.
Cash flow measures a company's ability to generate and use cash over a certain period through operating, investing, and financing activities. This is a dynamic indicator that reflects the financial health and liquidity of a company. If a company can consistently generate positive cash flow, it indicates that it has the ability to sustain and develop itself, pay off debts, make investments, reward shareholders, and respond to 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 paying attention to cash balances.
03
The Importance of Cash Flow from Operating Activities
Cash flow is divided into three parts:Cash flow from operating activities is the cash flow generated by a company's day-to-day operations, including cash received from the sale of goods and provision of services, as well as cash paid for raw materials, employee wages, and other operating costs. It demonstrates the company's basic profitability and operational efficiency from the perspective of cash receipts and payments, and is a core indicator for judging whether a company can maintain long-term operations and growth.
Cash flow from investing activities involves the inflow and outflow of funds in long-term assets such as fixed assets and investments in other entities, reflecting the company's long-term strategic layout and potential for future growth.
Cash flow from financing activities covers the company's sources of financing, including debt and equity financing, as well as cash flows related to the repayment of debt, payment of interest, and dividends, showing how the company balances its capital structure and funding needs through financing activities.
Among these three, cash flow from operating activities holds a central position. Just as the blood-making function is crucial for human survival, cash flow from operating activities is the foundation for a company's continuous operation and development. A healthy cash flow from operating activities can ensure that the company can sustain and develop itself without relying on external financing, and enhance its ability to withstand market fluctuations. A stable cash flow from operating activities also provides more options and flexibility for investment and financing activities, allowing the company to engage in investment activities and capital allocation under more favorable conditions.
How to manage cash flow from operating activities?
What are the determinants of cash flow from operating activities? Is it always better for cash flow from operating activities to be higher? These questions are worth exploring in depth.
Firstly, we need to understand that the formation of cash flow from operating activities is mainly influenced by two major categories of factors.
Income statement items. Profitability is the most important factor affecting cash flow from operating activities. Specifically, increasing sales revenue can increase cash inflow from operations, while controlling costs and expenses can effectively improve the cash outflow situation. Depreciation and amortization are non-cash expenses that reduce net profit but do not affect cash flow; on the contrary, they can make cash flow from operations exceed net profit.
For example, in the first half of 2024, BOE Technology Group Co., Ltd. had a net profit of only 1.771 billion yuan, but its net cash flow from operating activities reached 24.879 billion yuan, mainly due to depreciation and amortization expenses of 18.726 billion yuan; the high depreciation expenses also imply that the company may have significant investment expenditures in the future.Balance Sheet Items. In addition to profitability, inventory, accounts receivable, and accounts payable on the balance sheet also have a significant impact on cash flow. For instance, reducing inventory can decrease the capital tied up; accelerating the recovery of accounts receivable can increase cash inflows; and managing accounts payable effectively can balance cash outflows.
For example, in the first half of 2024, Sany Heavy Industry achieved a net profit of 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 2,204.61%, mainly due to increased sales collections and reduced procurement payments.
Although a higher cash flow from operating activities is generally considered a positive sign of financial health, this view is not absolute. For capital-intensive companies, a decline in sales may lead to a significant drop in profits, but due to the presence of high depreciation, the cash flow from operating activities may still be much higher than net profit.
However, this kind of cash flow is not sustainable, and the actual profitability is declining. The substantial investment required for future equipment upgrades may still plunge the enterprise into financial difficulties. Similarly, managing current assets and current liabilities in unconventional ways, such as delaying payments or accelerating collections, may improve cash flow in the short term, but this deviation from the regular business model is also unsustainable and may lead to long-term financial pressure or operational instability.
The ideal cash flow from operating activities should match the company's profitability. One of the commonly used indicators to measure this match 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 in line with its 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 and liability management strategies can a company maintain high-quality operating cash flow. If a company's profitability is insufficient, even if unconventional measures temporarily increase cash flow, this improvement is hard to sustain. In other words, a truly healthy cash flow from operating activities must be based on sustained profitability, rather than relying solely on short-term cash management strategies.
05
Managing Cash Balances
Determining the "ideal" cash balance is a complex but important task. The ideal cash balance should not only meet the needs of daily operations but also consider investment opportunities and the costs and opportunities of external financing.
Determining the Cash Needed for OperationsThe cash required for a company's operations typically includes cash needs for daily business activities, such as the purchase of raw materials, payment of employee salaries, rental expenses, taxes, and other operational costs. Determining this part of the cash requirement can be done using different methods. For example, the Cash Conversion Cycle (CCC) can be used to measure the number of days a company takes from paying suppliers to collecting sales revenue, and by optimizing inventory management, accelerating the recovery of accounts receivable, and reasonably adjusting the payment of accounts payable, this cycle can be shortened to improve the efficiency of capital use. Additionally, budgeting and historical data analysis can be used to identify seasonal fluctuations and long-term trends in cash needs.
Managing Investment Opportunities
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 versus making investments, analyze the expected returns of different investment channels, and conduct a detailed financial assessment of potential investments, including expected rates of return, potential risks, and investment time frames, to decide the most appropriate use of funds.
Understanding External Financing Costs and Opportunities
Different financing methods bring different costs and opportunities, and the right choice can significantly enhance a company's financial efficiency and market competitiveness. The costs of external financing mainly include interest expenses and potential dilution of equity.
For example, in August 2024, China's one-year Loan Prime Rate (LPR) was 3.35%, and the LPR for terms over five years was 3.85%. The cost of a company issuing bonds depends on credit ratings and market interest rates, while the cost of equity financing is more complex, depending on market valuations and investor expectations. Market interest rates, investor sentiment, and credit market conditions are key factors affecting financing costs and feasibility.
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 flows and high credit ratings may prefer to use debt financing to maintain equity control and reduce financing costs, while startups in the rapid growth phase may rely more on equity financing to obtain necessary development funds.
Considerations Based on Different Development Stages
Companies have different cash balance needs at different stages of development and must conduct corresponding financial management and planning based on the characteristics of each stage.
Startup Stage. Companies usually face higher uncertainty when they are first established, so they need higher cash reserves to support business establishment, product development, and market development. At the same time, startups may face issues of unstable income or tight cash flows, and higher cash reserves can also help alleviate financial pressure and ensure the survival and development of the company in the early stages.Growth Stage. As businesses enter the growth phase, the expansion of the market and the increase in investment opportunities demand more refined cash management. During this stage, companies require substantial funds for expansion, such as increasing production capacity, expanding into new markets, and developing new products. The focus of cash management is to ensure efficient capital allocation while maintaining sufficient liquidity to support the rapid growth of the enterprise.
Maturity Stage. Upon reaching the maturity stage, a company's cash flow typically becomes more stable, the business model becomes relatively mature, and the market share tends to stabilize. However, the company still needs to maintain a certain level of liquidity to cope with market fluctuations, technological updates, and potential merger and acquisition opportunities. In this phase, the company should make moderate innovative investments on a solid foundation, while remaining alert to market changes to address possible external challenges.
Decline Stage. In the decline stage, companies may face issues such as a decrease in market share and weakened profitability. At this time, the focus of cash management is to maintain operations or restructure the business through cost optimization and strict cash flow management. Companies need to cut non-essential expenses, concentrate resources to support core businesses, and look for opportunities to transform or adjust strategies to regain market competitiveness.
Why Cash is King
"Cash is King" is more than just a slogan; it reflects the central role of cash management—including the management of cash flow and cash balances—in the operation of a business. However, 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 movement of a company's cash, the income statement demonstrates the company's profitability, and the balance sheet reflects the company's financial structure. These three complement each other, providing comprehensive information support for business decision-making. Therefore, accurately understanding these three statements and effectively combining them can truly implement the concept of "cash is king," ensuring that the company maintains good operating performance and a robust financial condition amidst economic fluctuations and market uncertainties.