Why are cash flow and profitability both important in capital budgeting?

• A. Profitability equals cash flow.
• B. Cash flow is the same as revenue.
• C. Profitability is net income; cash flow is actual cash movement.
• D. Only profitability matters.

Answer: (C)

In capital budgeting, you need both earnings potential and actual cash generation to judge an investment. Profitability is typically measured by net income, which reflects revenues minus expenses (including non-cash items like depreciation). Cash flow tracks the real money moving in and out, capturing the timing of cash receipts and payments, working capital changes, and capital investments. Because non-cash items can depress or inflate net income, and because cash timing can differ from when profits are earned, an investment can appear profitable on the income statement but still face cash shortages, or vice versa. Therefore, both measures matter: profitability shows earnings power, while cash flow shows liquidity and the ability to fund the project and return value to investors. The correct choice distinguishes net income from actual cash movement, unlike the other statements that conflate or misstate these concepts.