The Balance Sheet & Cash Flow

Introduction

The balance sheet shows what a company owns and owes at a moment in time, while the cash flow statement shows real cash movement. This lesson explains both and why liquidity matters.

The Balance Sheet

The fundamental identity:

Assets = Liabilities + Equity

• Assets — cash, inventory, property, receivables
• Liabilities — debt, payables, obligations
• Equity — what belongs to shareholders

Reading Solvency

Compare debt to assets and equity:

• High debt = more financial risk and interest cost
• Strong equity = a cushion against downturns
• The balance sheet reveals whether a company can survive hard periods

The Cash Flow Statement

Cash flow is split into three:

1. Operating — cash from core business (most important for quality) 2. Investing — cash spent/bought on long-term assets 3. Financing — cash from debt, issuing shares, dividends

Profit vs Cash

A key insight: profit is not cash.

Revenue recognized (profit) vs cash actually received
Expenses recognized vs cash actually paid

A company can show a profit yet be short on cash due to unpaid invoices, inventory build-up, or capital spending.

Why This Matters

• Operating cash flow confirms earnings are real
• A healthy balance sheet means the company can weather downturns and fund growth
• Comparing net income to operating cash flow reveals earnings quality

Real-World Example

Company A reports $10M profit but only $2M operating cash flow — invoices unpaid, inventory piling up. Company B reports $10M profit with $11M operating cash flow. Company B's earnings are far higher quality.

Summary

• Balance sheet: Assets = Liabilities + Equity
• It reveals solvency and financial risk
• Cash flow has operating, investing, and financing parts
• Profit ≠ cash; operating cash flow confirms earnings quality
• A strong balance sheet and real cash flow mean a resilient business

Next Lesson

Now the ratios that judge profitability.