Comparing profit to cash is like comparing water to oxygen!
Both are obviously important. Without water, you might still make it for 3 to 7 days, but without oxygen, it's a matter of minutes, maybe an hour at best.
So, speaking of importance, it's clear that cash is more crucial than profit for a company.
But what I'm saying here is about priority, which means, it doesn't mean profit isn't important.
Is that so? You bet it is!
Table of Contents
- The Amazon Story: A Testament to the Cash vs. Profit Debate
- Amazon's Cash-First Strategy: Rethinking Profit Priorities
- Amazon's Profit Puzzle: The Cash vs. Profit Dilemma
- Sacrificing Cash for Profit: The Risky Trade-off
- Consequences of Sacrificing Cash for Profit
- Boosting Valuation: Leveraging Profit
- Cash vs. Profit: Key Conclusions
The Amazon Story: A Testament to the Cash vs. Profit Debate
Quoting from businessmodelanalyst.com, Amazon first turned a profit in 2003. Before that, the company had been facing losses from its start in 1994 until 2002. [1]
What does that mean???
It means Amazon went through about nine years of losses before finally making a profit in 2003.
Could they survive? Well, apparently. As of April 14, 2024, according to data from companiesmarketcap.com, Amazon ranks 5th! [2]
| Rank | Company | Market Cap |
|---|---|---|
| 1 | Microsoft | $3.178 T |
| 2 | Apple | $2.726 T |
| 3 | NVIDIA | $2.265 T |
| 4 | Alphabet (Google) | $1.989 T |
| 5 | Amazon | $1.966 T |
But how did they manage that? Well, they did! One of the most significant factors for Amazon is the trust investors have in its future growth.
Why is that important?
It's crucial! Even when Amazon was incurring losses, they could keep their operations going because investors kept pumping money into them.
Why would investors do that?
Well, it's because they believe in Amazon's potential for future growth, which has been validated up to 2024.
Investor funds, besides covering operational costs, also fuel their long-term investments.
What can we conclude from this?
Amazon's Cash-First Strategy: Rethinking Profit Priorities
Amazon doesn't prioritize profit because they choose not to.
Wait, what's this? Is this even possible?
Yes, it is. As quoted from procurify.com, Jeff Bezos believes that at Amazon, the importance of cash to support growth and innovation outweighs the focus on profit. He prioritizes using cash for experiments and long-term investments, even if it means short-term losses. [3]
Whether you like it or not, this is the reality. This isn't the 70s or 80s where profit was the main measure of company valuation.
Did profit determine a company's valuation back then?
Certainly, it did. Just take a look at those old theories that still guide some financial textbooks!
You'll find that calculating a company's profit involves discounting future net income or dividends to their present value.
| Dividend Discount Model | |
|---|---|
| Price per Share | D / (r - g) |
| D | The estimated value of next year’s dividend |
| r | The company’s cost of capital equity |
| g | The constant growth rate for dividends |
Doesn't that involve future prospects as well?
Exactly! But the issue is, in those textbooks, it's also stated that a company should have stable profits and profit growth for the previous 3-5 years so we can calculate its future growth rate.
Imagine that applied to today's startup companies that continuously invest in growth for years to dominate the market.
A company can keep on losing money but still have a much higher valuation than a company with steady and stable profits for several years.
How is that possible? Well, the answer lies in the company's future prospects!
Investors are willing to keep pouring funds into companies with high and disruptive innovation. Take Amazon, for example. You can shop for anything from your smartphone, while lying down.
Who can beat Amazon right now?
Amazon's Profit Puzzle: The Cash vs. Profit Dilemma
Going back to the main point I'm making here, which is cash versus profit.
We've briefly touched on how Amazon can keep going without profit but not without cash.
Jeff Bezos works tirelessly to maintain relationships with his investors to keep them pouring funds into his company.
Imagine, back in 2013, as quoted from Nasdaq, investing in Amazon stocks was more of a speculative move. [4]
Why was that?
Well, even though Amazon's revenue kept growing, they struggled to turn a profit (or intentionally avoided it). That's because they kept expanding into various products, so the company almost always only reached the breakeven point or very minimal profit.
Yet, their stock was still highly valued by investors; even at the end of 2013, as quoted from macrotrends, it reached 674x. [5]
Incredible!
Sacrificing Cash for Profit: The Risky Trade-off
Without profit or insufficient profit performance, a company can still keep growing as long as investors believe in it. But what if there's no cash?
A company that consistently turns a profit but neglects its cash flow could end up in big trouble!
Wait, how come?
Well, for example, to boost profit, a company might relax its credit terms or extend its payment deadlines.
That's risky business, especially if the company can't negotiate with its suppliers. Because where will it find the money to pay them?
Picture this: to boost profit, a company lures in customers by offering them a three-month payment window, while the company itself needs to settle its bills within a month, not to mention covering salaries, utilities, and other short-term expenses.
Remember, a healthy net working capital is vital! Net working capital is calculated by subtracting current liabilities from current assets.
Consequences of Sacrificing Cash for Profit
If a company sacrifices its cash for profit by extending credit terms, what happens?
On the asset side, cash decreases, inventory decreases, but accounts receivable increases. Meanwhile, current liabilities keep piling up.
Accounts payable increase because the company keeps stocking up on inventory but can't pay because there's no cash, or if they manage to pay, it might be through bank loans, which means current liabilities increase due to the surge in bank debt!
| Current Assets | Current Liabilities |
|---|---|
| Cash (Decreases) | Accounts Payable (Increases) |
| Accounts Receivable (Increases) | Bank Payable (Increases) |
| Inventories (Decreases) | Salaries Payable (Increases) |
It's a nightmare for the company's operations once it starts boosting profit by sacrificing cash!
From the profit side, it's also hit because loans will rack up interest expenses. These expenses in the profit and loss statement will eat into the company's net profit.
Boosting Valuation: Leveraging Profit
However, not much different from companies focusing on cash, companies focusing on profit can also rely on accrual accounting to increase their company's valuation by exploiting the company's profit advantage.
Remember what I said earlier about how financial textbooks calculate a company's valuation? With its net profit! Yes, with its net profit. It could be by discounting its dividend per share or its earnings per share.
If lucky, a company can raise funds by issuing new shares to attract investors to pour their cash!
Once more, net profit can be dolled up by the company to lure in fresh funds from investors for financing its day-to-day operations or long-term ventures.
Cash vs. Profit: Key Conclusions
So, what does it mean? Which one is more important, profit or cash? Cash is more important because it can finance operations and long-term investments.
Is net profit important then?
It's important!! As long as its net profit generates enough cash to ensure a positive net working capital. So, if a company attracts investor funds because of its good net profit performance, the funds aren't for working capital, but for long-term investment costs and R&D expenses.
ARTICLE SOURCES
- Is Amazon Profitable? by Daniel Pereira. The Business Model Analyst. https://businessmodelanalyst.com/is-amazon-profitable/. (accessed April 13, 2024)
- Largest Companies by Market Cap. https://companiesmarketcap.com/. (accessed April 13, 2024)
- Return on Failure: Why Jeff Bezos Doesn’t Believe in Profit. procurify. https://www.procurify.com/blog/manage-cash-flow-jeff-bezos/. (accessed April 13, 2024)
- Will Amazon Ever Make Money? nasdaq. https://www.nasdaq.com/articles/will-amazon-ever-make-money-2013-10-24. (accessed April 13, 2024)
- Amazon PE Ratio 2010-2023 | AMZN. macrotrends. https://www.macrotrends.net/stocks/charts/AMZN/amazon/pe-ratio. (accessed April 13, 2024)
