Overview – What do they tell you? Part 2
This article is Part 2 of the supplement to the white paper…
…providing a broader view of financial statements and what each statement tells you about a business. This article can be read before or after the more detailed white paper.
We have three financial statements to consider here: the Income Statement (found in Part 1), and Part 2: the Balance Sheet, and the Cash Flow Statement.
The Balance Sheet is very different from the income statement. It is basically a “snap shot” of amounts of cash (an asset), non-liquid assets, and what a company owes in liabilities at the point in time (date) of the statement. Additionally the balance sheet also shows a company’s Equity – often called net worth.
The cash account, which is usually the top line in the asset section of the Balance Sheet, is the only place that reflects where a company can get instant cash to purchase something – not the Sales line of the Income Statement.
A word about Assets: I look at the balance sheet as a picture of how many assets a company owns – versus their liabilities. If you were to liquidate a company’s assets, what would be the expected cash that could be generated by collecting what the company is owed (Receivables), sales of remaining products (Inventory), and sales of depreciated physical items that the company owns (Net Fixed Assets)?
Liabilities are what a company owes to its suppliers (Payables), what it owes in unpaid principal on loans (Short and Long Term Loans) and any other debt a company may have.
An overall view of the Balance Sheet will tell you if the company has net worth -meaning their Assets are Larger than their Liabilities. The numbers reflected in the Balance Sheet changes for each account from period to period are a measure of Cash Flow:
- An increase in Assets represents a negative cash flow,
- an increase in Liabilities represents a positive cash flow, and
- an increase in Equity represents a positive cash flow.
Cash Flow Statement
The Cash Flow Statement is another important measure of how a company is doing. A financially healthy company will demonstrate consistent positive cash flow… money flowing into the business is good where cash flowing out of a business can be bad.
I would recommend you read my white paper found here to get more details beyond the simplified overview in this article.