Financial Analysis: Profit, Assets, and Cash Flow

Introduction

Understanding the relationship between profit, assets, and cash flow is crucial for assessing a company's financial health. This document provides an in-depth analysis of these three key financial metrics and how their alignment can indicate the true strength of a business.

Situations and Examples

Situation 1: High Profit + Low Cash Flow = "Paper Rich" Fraud

• Characteristics:
• Pretty profit statements, but persistent negative operating cash flow.
• Rapid increase in accounts receivable (unrecoverable or fake), customers not paying.
• Profit unable to convert into real cash.

Note: This is due to the accrual basis of accounting, which allows for discrepancies between reported profit and actual cash inflow.

Example: LeEco (2014–2017)

Problems:

• Sales primarily through related parties, with fabricated transactions.
• Agressive revenue recognition without actual cash collection.
• Eventually exposed: bad debt provisions and financial collapse.

Conclusion: High profit ≠ earning money; focus on whether it can be converted into real cash.

Situation 2: High Assets + Low Profit = "Heavy but Weak" or Asset Inflation

• Characteristics:
• Huge total assets, but extremely low ROA (Return on Assets).
• High proportion of fixed assets, construction in progress, and goodwill.
• Significant investment without generating returns.

Example: Some "PPP Project Companies" or "Pseudo-Tech Enterprises"

Problems:

• "Construction in progress" not transferred to fixed assets to avoid depreciation expenses affecting profit.
• Huge goodwill from acquisitions, with significant impairments later on ("big bath").
• Actual capacity utilization less than 30%.

Conclusion: More assets do not necessarily mean better; focus on "profitability."

Situation 3: High Cash Flow + Low Profit/Low Growth = Unsustainable or Hidden Risks

• Characteristics:
• Good operating cash flow, but low profit or declining.
• Potentially due to one-time actions (e.g., asset sales, cost cuts).

Example: A Traditional Manufacturing Company "Cutting Limbs to Survive"

Problems:

• Positive cash flow due to "not spending" rather than "earning more."
• Cuts in expenses bring short-term cash inflow but harm long-term competitiveness.
• Analogous to "starving for weight loss," short-term gains, long-term decline.

Conclusion: Positive cash flow ≠ healthy company; examine the sustainability of the cause.

Situation 4: Disconnected and Abnormal Indicators = Typical Financial Fraud

Case Study: Kangmei Pharmaceutical (2019 Scandal)

Key Red Flags:

• High deposits: Bank balance of 30 billion RMB, yet paying high interest on loans?
• Interest expense much lower than expected.
• Audit findings reveal discrepancies in bank confirmations.

Conclusion: Severe misalignment between profit, assets, and cash flow → key to identifying fraud.

How to Determine Synergy? - Practical Analysis Framework

Conclusion

The synergy between profit, assets, and cash flow is the key to assessing a company's true health. High reported profits do not necessarily mean earning money; it is crucial to ensure that these profits can be converted into real cash. A large asset base does not guarantee profitability, and positive short-term cash flow does not always indicate long-term financial stability.

Key Takeaway:

The alignment of profit, assets, and cash flow is the hallmark of a "truly healthy company."