Stocks and flows
Financial statements provide a snapshot of the financial condition of an organisation. This snapshot is based on a model of how an organisation operates from a financial perspective, and this comprises stocks and flows.
Stocks are financial values present at a certain moment in time. For example, the assets that a company owns on a certain date (such as land, buildings, equipment and machinery, patents and inventory) are stocks. Similarly the debts that a company owes to creditors are stocks.
Flows, on the other hand, are financial values that accumulate over a period of time. For example, the net income (profit or loss) that a company makes during a period of time (such as one accounting year) is a flow. In the same way, the costs that a company sustains during a period of time are flows.
The financial condition of an organisation can therefore be represented as the total amount of stocks of the organisation at a given time. In accounting terms, we distinguish between three categories of stocks: assets, liabilities and equity.
Assets are what an organisation owns and which contribute to the organisation’s activities. Liabilities are what an organisation owes to creditors. Assets and liabilities may not necessarily tally: typically an organisation owns more assets than it owes to creditors. This difference between assets and liabilities is called equity (or sometimes, in the public sector, reserves). Equity is a stock that refers to the amount of net wealth that the organisation possesses.
How does the financial condition of an organisation change over time? We can find the answer to this question through the analysis of the flows that occur in a given period. Accountants are particularly interested in the flows of income (revenue) and costs (expenses) in an accounting period. When income exceeds costs, then the organisation makes a profit and its financial condition will be seen to have improved during the period of time. This is reflected in an increase in the equity that the organisation has between the beginning and the end of the accounting period.
Accountants also pay close attention to another important flow, which is the cash flow. Cash flow is the net amount of cash that is handled by an organisation in a given period of time. Cash flow is the difference between two flows, namely the cash inflow (the money received from payments, for example from customers) and the cash outflow (money for payments, for example to suppliers, employees and taxes). When the cash flow is positive, the organisation has increased its amount of cash (referred to as its liquidity) over time.