P&L, Balance Sheet, and Cash Flow 101

Chris Schwalbach  ·  December 19, 2016  ·  2.8 min

The core financial statements of a business are comprised of the following three documents: a statement of profit and loss (also referred to as a “P&L”, or an “income statement”), a balance sheet, and a statement of cash flow.   By using these correctly, you can get a full understanding and analysis of your operations and company accounting, and use your own data to drive your business forward.  Not using these means you are likely “flying blind” – a scary thought…

The first, the P&L, is a representation of the operations of a business during a specific period of time. Please note that the P&L will not necessarily correspond to the amount of cash you have in your bank account. (This will be explained in the statement of cash flows). Below is a sample summary of a high level accounts of statements of profit and loss. Please note that this is meant to be a high level explanation, and is by no means an all-encompassing detail.

As an example for this article, let’s pretend that we are a company selling bottled water.

 

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A Balance Sheet is a snapshot of the business during a specific period of time that shows the following:

  • Assets – Everything you own / that is owed to you
  • Liabilities – Everything that you borrow / owe
  • Equity – The financial value of the business including all money the business has made or lost from operations, plus invested equity capital, less distributions
  • Assets = Liabilities + Equity – this always holds true by definition

 

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The Statement of Cash Flows allows analysis / separation of profitability from cash of the business by reconciling the P&L and balance sheet to cash.  Before we dive into the statement itself, let’s think logically about a few examples of how cash could be affected by things other than what’s on the P&L as mentioned earlier.

Example: I sell you multiple cases of water, but you don’t pay me for 120 days.   What does this mean for cash?  Explanation: While I was able to show revenue on the P&L, my cash balance didn’t increase because I haven’t gotten paid yet.  (This is good for profitability, but bad for cash flow).

If on the other hand, we have an example where a customer paid us up front for a year’s supply of water, our cash would increase a lot, but we could only show 1/12 of that money each month on the P&L.  (This is good for cash flow, but shows lower revenue / profitability).

As you can see, there are a lot of things that affect cash other than what’s on your P&L, so it’s extremely important that this sheet is reviewed as well.

Let’s take a look at an example statement of cash flows below, and see how it works by reconciling your statement of profit of loss, and the changes in your balance sheet from the prior period to your cash balances.  In other words, this statement shows you how much your cash changed from the prior period, and what caused it – VERY important!

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Using these three core financial statements correctly, you can get better insights to help propel your business forward.  Not using these would be a costly mistake.

 

By John Rose
AVL Growth Partners, 2016