Cash flow statement or Three great rivers

3 mars 2023

Today we're going to start taking apart the third and final report that the company publishes each quarter and year - it's Cash flow statement.

Remember, when we studied the balance sheet, we learned that one of the company's assets is cash in accounts. This is a very important asset because if the company doesn't have money in the account, it can't buy raw materials, pay employees' salaries, etc.

What, in general, is a "company" in the eyes of an accountant? These are assets that have been purchased on credit or with equity, for the purpose of earning a net income for its shareholders or investing that income in further growth.

That is, the source of cash in a company's account may be profits. But why do I say "may be"? The point is that it's possible to have a situation where profits are positive on the income statement, but there is no money physically in the account. To make sense of this, let's remember the workshop I use in all the examples. Suppose our master sold all of his boots on credit. That is, he was promised payment, but later. He ended up with a receivable in assets and, most interestingly, generated revenue. The accountant will calculate the revenue for these sales, despite the fact that the shop hasn't actually received the money yet. Then the accountant will deduct the expenses from the revenue, and the result will be a profit. But there is zero money in the account. So what should our master do? The orders are coming in, but there is nothing to pay for the raw materials. In such circumstances, while the master is waiting for the repayment of debts from customers, he himself borrows from the bank to top up his current account with money.

Now let us make his situation more complicated. Let us assume that the money borrowed he still does not have enough, and the bank does not give more. The only thing left is to sell some of his property, that is, some of his assets. Remember, when we took apart the assets of the workshop, the master had shares in an oil company. This is something he could sell without hurting the production process. Then there is enough money in the checking account to produce boots uninterrupted.

Of course, this is a wildly exaggerated example, since more often than not, profits are money, after all, and not the virtual records of an accountant. Nevertheless, I gave this example to make it clear that cash in the account and profit are related, but still different concepts.

So what does the cash flow statement show? Let's engage our imagination again. Imagine a lake with three rivers flowing into it on the left and three rivers flowing out on the right. That is, on one side the lake feeds on water, and on the other side it gives it away. So the asset called "cash" on the balance sheet is the lake. And the amount of cash is the amount of water in that lake. Let's now name the three rivers that feed our lake.

Let's call the first river the operating cash flow. When we receive the money from product sales, the lake is filled with water from the first river.

The second river on the left is called the financial cash flow. This is when we receive financing from outside, or, to put it simply, we borrow. Since this is money received into the company's account, it also fills our lake.

The third river let's call investment cash flow. This is the flow of money we get from the sale of the company's non-current assets. In the example with the master, these were assets in the form of oil company stock. Their sale led to the replenishment of our notional money lake.



So we have a lake of money, which is filled thanks to three flows: operational, financial, and investment. That sounds great, but our lake is not only getting bigger, but it's also getting smaller through the three outgoing flows. I'll tell you about that in my next post. See you soon!