A Simple Financials Example

Chapter 14: About Business Numbers - Page 14.6

A Simple Financials Example

One of the best ways to understand the dilemma of cash vs. profits is to follow an otherwise-profitable company going broke because it can't meet its obligations. This is a quick and simple example. It also leads us into the relationship between income statement, balance sheet, and cash.

Start with $100, which we'll call capital. At the beginning of this exercise, your balance sheet has assets of $100 — the money — and capital of $100. Assets are equal to capital plus liabilities. A summary of the simple financial statement at this point is shown in this first illustration, Case Starting Point.

Simple Case Starting Point

The simple financials show a hypothetical widgets business as it starts.

If you buy a widget for $100 and sell it for $150, you should end up with $50 profit, which is what your income statement covers. Sales minus costs are profit. You should have $150 in the bank. Now your balance sheet shows the same $100 in original capital plus $50 in earnings, which are equal to the $150 you have in cash as an asset. The next illustration shows you how the financials look right after that sale.

Buy another widget for $100 and sell it again for $150, and now you have $200 in the bank. Do it again, you have $250 in the bank. Your income statement shows sales of $450, cost of sales of $300, and profit of $150. At this point your business has sold three units and made $150 profit. In theory it has $250 in the bank.

One Widget Sold

This table shows the financials after the first sale.

Now with Three Widgets Sold

Now the company has sold three widgets and made a profit.

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