Recently, a close friend asked: What is cashflow? I don’t get it. How is it different from my Income Statement?
This post will be geared towards a total beginner, a blank slate, and will offer links to a deeper understanding of cashflow.
First, let’s quickly review the context of finance.
In finance, there are 3 primary statements, which track our income, wealth, and cash:
The Balance Sheet
The income statement shows income - expenses = net income.
The balance sheet shows assets - liabilities = net equity/worth
The cashflow statement shows the fluctuations in your cash based on the influences from your income, expenses, assets, and liabilities.
As you can see the cashflow statement is the bridge linking between the income statement and the balance sheet.
You have some assets (currencies/cash, commodities, equities, and/or bonds), you also have some liabilities (student loans, credit cards, personal loans, etc.). This information is tracked in your balance sheet. Notice cash sits here as an asset.
You also have a salary you earn every month from work you preform, or alternative income sources from various work preformed, or maybe you own an asset which pays you regularly, then you spend some of that income, or all of it on your life’s needs and wants. This information is tracked in your income statement.
However, the pile of cash you posses changes and fluctuates over time based on two separate set of activities which are not accounted for in the same statement. So, how do we account for the changes in cash from expenses as well as debt repayments, or purchasing of assets/ income from assets as well as income from an employer? The answer is the Cashflow Statement.
The Cashflow Statement shows you how your cash is changing over time, based on the use cases: Income, Expenses, Assets, Liabilities.
There are 3 components to a cashflow statement:
Cashflow from Operating Activities = Income Statement
Cashflow from Investing Activities = Linked to Assets
Cashflow from Financing Activities = Linked to Liabilities
If you have no Assets and no Liabilities, then your Income Statement is your Cashflow Statement. However, if you’ve taken out and are repaying any loans, if you’ve been investing in assets/ receiving payments from assets; then the cashflow statement is critical for your understanding of how your cash position is fluctuating and for what specific reasons.
In order not to overwhelm, and keep this simple, we’ll end here.
For further understanding, cashflow formula, cashflow patterns follow these links: