Skip to 0 minutes and 15 seconds What a company or a public sector entity owns is its wealth. In accounting terms, wealth is formed of assets and liabilities. Assets minus liabilities equals capital. This is the fundamental accounting equation that must always hold in any company or public sector entity. Companies and entities can borrow money. Money borrowed might be used to increase the asset base, but it also adds to the debt. Assets, liabilities, and capital are stock values because they exist at any particular moment in time. Income or revenue is generated through what the company charges or sells. The company also has expenses. Paying staff, buying services, and paying interest on debt.
Skip to 1 minute and 7 seconds Over an extended period of time, the difference between how much the company earns and how much it consumes tells us its net income. For businesses, hopefully the net income shows a healthy bit of profit. Public sector entities, instead, do not aim to make a profit. If they do make a loss, however, they erode their capital and jeopardise the running of their business in the future. Income and expenses are flow values because they exist over a period of time. But remember, net income is different to cash flow which is the amount of money flowing in and out in a period of time.
Skip to 1 minute and 50 seconds That cash may come in from charging for services, collecting taxes, or selling assets, and it may go out to pay salaries, purchase services, or pay back loans. Net income and cash flow are related, but they are not the same kind of flow. For example, a company earns an income when they sell goods or services, but they do not have any cash inflow until they receive payment from their clients. Cash flow is important. It’s the lifeblood of any company and tells us just how healthy the company’s finances really are.
Introduction: stocks and flows
How do we measure and track what a company owns?
This short animation introduces some basic accounting concepts used to measure and track income and cash flow.