Don’t Drive Blind
For many of us, financial statements are something we prepare annually in order to file our tax returns. However, failing to use timely financial information proactively is like driving blind.
As we’ve seen in previous lessons, business is complex. There are lots of interdependencies and delays. Without the use of dynamic tools – like the simulating model we’ve been using in this course – it’s tough to anticipate how decisions made today will impact performance in the future.
New Tools for Old Problems
Accounting is as old as civilization. Even the system of debits, credits, and ledgers that yield the familiar income statement, balance sheet, and cash flow statement date back to the Renaissance.
- The balance sheet measures stocks. Stocks are accumulations measured at a point in time. Cash, accounts receivable, accounts payable, and equity are stocks measured in dollars as of a specified date.
- The income and cash flow statements measure flows. Flows are measured in units per time period: dollars per month, for instance. Sales, cost of goods sold, and rent expense are flows reflected on the income statement. Net changes in accounts receivable is a flow measured on the cash flow statement.
The double entry accounting system is really very clever. It does an admirable job of capturing the financial stocks and flows of a business. Even so, it can be tough to impart a sense of the dynamics of business with columns of numbers. That’s why we find visual simulations so useful.
As I show in this video lesson, the visual model we’ve been using maps directly to the more familiar accounting statements. We can represent the same information in the form of an income statement, cash flow statement, and balance sheet in a spreadsheet. The difference, though, is that of watching a movie versus a series of photographs. Movies are just better at capturing dynamics, and business is dynamic.PLAY WITH THE CASH CYCLE MODEL
As human scale businesses grow, interdependencies among inventory, marketing strategies, and finance interact in complex ways. We can help you tame that complexity in order to develop confidence in your projections of cash and other key resources.