Let’s take a look how Cash Flow, investment and profit are interlinked with each other in a business organization. This article describes the relationship between cash, investment and profit.
CASH
Cash is finance needed to pay for investment!
Investment expenditure requires the use of cash for initial capital. Different investments can be financed differently – by long-term bank loans, debentures or selling shares. Large multinational conglomerates usually have multiple revenue streams to pay for their investments. This will also affect the cash flow position of a business as Net Cash Flow is likely to be negative in the short term.
Good Cash Flow is important for catching investment opportunities while poor Cash Flow will result in missed opportunities.
INVESTMENT
Investment is needed to earn profit!
The uses of cash for investments are not directly linked to a firm’s main trading activities – producing and selling products. It is because investment must happen before the products are even produced and sold.
Investment in a business is understood as the purchase of new means of production to increase productive capacity. Investment can be building or buying a new factory, buying a new machine, purchasing a new IT system, etc. Increasing capacity means that a business is able to produce more products to meet the growing demand generating more sales revenue. And, increasing productivity means producing more products within the same period of time, or producing the same number of products within shorter period of time.
Investment in NOT buying shares on the stock market or investing in banking products!
When a firm obtains finance for a new investment, Cash Inflows improve the firm’s liquidity position. But as the business buys the investment, it experiences an increase in Cash Outflows. Later, when the business sells an investment, it experiences an increase in its cash flow position again.
PROFIT
Profit provides new cash for more investments in the future!
Consequently, it is important to mention that these Cash Inflows and Cash Outflows from various investments do not directly affect the firm’s profitability. Again, because investments happen before the products are produced and sold, so they have nothing to do with profitability.
In short, effective Cash Flow management and Product Portfolio management are therefore necessary requirements for the business that wants to invest to turn cash into profit for its shareholders (owners) through an investment.
