Profitable on Paper but Going Under? — The Final Piece to Spotting a 'Cash-Poor Company'

Cosmos: "Up until last time, we talked about the P&L (Profit and Loss Statement) and the BS (Balance Sheet).We looked at the 'muscles' with the P&L and the 'skeleton' with the BS.."

Yell: "Yeah. I feel like I've started to understand what a 'company that is earning properly and is unlikely to go under' looks like."

Cosmos: "Alright, then here is the final question."

Cosmos: "Operating profit is positive. Net income is in the black. The equity ratio is over 30%, so it's 'pretty safe' from a BS perspective.Why do you think a company like that could still be 'cash-poor'?."

Yell: "Huh...? What do you mean by being in the black and not having much debt, but still being cash-poor?"

Cosmos: "That actually happens quite often. That's what we're talking about today. The final piece of the financial statements: the 'Cash Flow Statement (CF)'."

Profitable but no cash? — The 'gap' between P&L and actual cash

Cosmos: "For example, let's say there's a company that's selling a ton of products."

Yell: "Yeah."

Cosmos: "But let's say most of those sales are on 'credit'. In other words, they've handed over the goods, but they haven't received the money yet."

Yell: "Ah...accounts receivable, right? I saw that on the BS."

Cosmos: "Exactly. In this case, on the P&L, 'sales' are recorded and 'profit' is generated. But,no money has actually entered the company's bank account.."

Yell: "Wait, does that mean...even though it looks 'great' on the financial statements, there's actually no cash at all?."

Cosmos: "Yes. The P&L tells you 'whether you made a profit.' But it doesn't tell you'whether your cash actually increased.'."

Yell: "Isn't that super scary? You think you're safe because you're making a profit, but in reality, you're about to run out of cash?"

Cosmos: "Exactly. That's why the P&L and BS aren't enough. You need to look at the final piece: the 'flow of money'."

What is a CF statement? — To put it super simply

Yell: "So, looking at that'flow of money' is what the CF statement is for, right?"

Cosmos: "Yes. The CF statement is a document that tells you 'how the contents of the company's wallet moved.'"

Yell: "The contents of the wallet..."

Cosmos: "Right. So, the flow of money is divided into three main categories."

1. Operating Cash Flow (Did money increase from core business?)

Cosmos: "This is the most important one. Whether you are actually earning money from your core business."

Yell: "Is it similar to 'Operating Profit' on the P&L?"

Cosmos: "Yes. But unlike the P&L, it's calculated based on "}, {actual money that came in. If this is positive, it's proof that money is circulating through your core business."

2. Investing Cash Flow (Did you spend money on equipment, etc.?)

Cosmos: "The movement of money used to build new factories or buy machinery. Basically, it's often negative. Because you're investing for the future."

Yell: "I see. So even if it's negative, it doesn't necessarily mean it's 'bad'."

3. Financing Cash Flow (Did you borrow or repay debt?)

Cosmos: "Borrowing money from banks or paying it back. Also, raising funds by issuing stock. If this is positive, it means you're raising money from external sources."

Yell: "It's simpler than I thought. There are only three."

So, what should I look at?

Yell: "So, which numbers should I actually look at?"

Cosmos: "At first, I think you only need to look at 'Operating Cash Flow'."

Yell: "Just that?"

Cosmos: "Yes. If this is positive, it means money is properly coming in from your core business. Conversely, if a company has an operating profit but negative operating CF, you should stop and think, 'Wait a minute?'"

Yell: "Like that 'buy now, pay later' company from earlier?"

Cosmos: "Exactly. You'll be deceived if you only look at the P&L, but if you look at the CF as well, you can see the 'company that truly has money'."

Only when all three are together can you see the full picture

Cosmos: "With this, we have all three pillars of the financial statements."

· PL (Profit and Loss Statement): Muscles. Is it earning properly?
· BS (Balance Sheet): Skeleton. Is it a body that won't collapse easily?
· CF (Cash Flow Statement): Blood. Is money circulating properly?

Yell: "You know, at first I was like 'What is profit?'', but I've come this far..."

Cosmos: "Right? When you look at these three as a set, the company starts to look three-dimensional."

Yell: "Next time I look at a financial statement, I feel like I'll be looking for 'Operating Profit', 'Equity Ratio', and 'Operating CF'—these three things."

Cosmos: "Yell, you remember them well! If that's the case, then this series was worth doing."

Cosmos: "I think next time you look at a financial statement, you won't just think 'it looks okay,' but you'll actually scroll down to the CF."

Next Episode Preview: Practical Application—Let's read that company using the knowledge we've learned

Cosmos: "With today, we have all the basics of financial statements: PL, BS, and CF."

Yell: "Yeah. I feel like I've gained a little bit of confidence."

Cosmos: "And you know, I'm thinking of trying a little experiment next."

Yell: "An experiment?"

Cosmos: "I wrote an article before that has a somewhat difficult company analysis... I want to see how you would read it now, Yell."

Yell: "Wait, I'm the one doing the analysis!?"

Cosmos: "Yeah. Let's see how that company looks when viewed through the three lenses of PL, BS, and CF. Let's do it together."

Yell: "...It makes me nervous, but I think I'm looking forward to it."

Cosmos: "Right? Because knowledge only becomes 'your own' once you try using it."

Cosmos: "Oh, that's right. If there's a company you want Cosmos and Yell to explain, please let us know in the comments section. We'd like to read it together."

Yell: "Oh, that's a great idea! It feels like we're all studying together."

Cosmos: "Yeah. Investing is scary when you do it alone, but I feel like it's reassuring when we can think about it together like this."

Yell: "Let's check it out together next time!"

Cosmos: "Finally, when it comes to financial statements, remember: 'Look at the PL for muscle, the BS for skeletal structure, and the CF for blood flow.' But you know... there might still be a part of the financial statements you 'think you've looked at properly' that you're missing."

For those who want to read the financial statement series from the beginning

Article on muscle (PL)

Article on skeletal structure (BS)

Recommended articles

Thank you for reading until the end🌸
Let's continue to learn step by step together.

#FinancialStatements #CashFlowStatement #CF #OperatingCF #PL #BS #HowToReadFinancialStatements #StockInvestmentBeginner #InvestmentBeginner #FinancialStatementSeries #CosmosInvestmentClassroom #Cosmos #Yell

※This article explains basic investment knowledge. It does not recommend the buying or selling of any specific stocks. Please make investment decisions at your own risk.