Pelican Parts Forums - Business Financial Numbers Question

Financial statements are comprised of three pieces: The Balance Sheet, Income Statement and Cash Flow Statement. While they interrelate, they represent three very different, and important views on how a business functions. If you look only at one, you are not seeing the entire picture of the financial health of an enterprise.

In short, the P&L tells you if the business is profitable and how profitable: Sales - cost of sales - costs of running the business > 0;

The balance sheet tells you if the business is healthy. Look up the "quick ratio" which is current assets / current liabilities. Looking at the balance sheet over multiple periods helps diagnose if the business is improving or regressing - growing inventories, growing payables, etc. that are not in relation to changes in revenue. You can have a nice looking P&L, but a bad balance sheet - it's easy to shift items off the P&L and into the balance sheet to make the business look better short term. This is a common issue when selling a business.

Finally, the cash flow statement tells you how long the business can endure. You generate cash from selling (actually from collecting); you consume cash to produce goods, run the lights, pay employees, acquire materials (inventory), capital equipment, etc. If the business consumes more cash than it generates, then you need a source of cash other than from the customers. For example, the P&L might show $500 in net income from $1,000 in sales - but the cash flow statement shows that you had to purchase $1,000 of materials so the cash flow is negative $500. What kills most businesses that are growing rapidly is an inability to have enough cash on hand to fund increasing operating expenses before customers pay for goods.

Let's say you own an ice cream store. The vendors that sell you milk, etc. give you Net 30 terms and deliver on 10/1; if you can't sell enough ice cream (cash sales) by 11/1 to cover the costs of the milk, rent and your employees, then you need to have extra cash on hand to pay your vendors. This obviously is more complicated if you are a manufacturing company that takes a few months to make the products you sell, then you collect (hopefully) from your customers within 30 days of selling the goods. When you layer on growth (buying more and more raw materials) then sources of cash other than from customers - either from retained earnings or line of credit/financing - is the oxygen companies need to thrive.