Back-to-Basics: Connections between the 3 Financial Statements

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I have tried to teach myself these connections a few times in my journey…but for some reason, never pursued it with diligence :frowning:

Perhaps I was waiting for the right teacher :slight_smile:, and his brilliantly simple and powerful “picture-driven” way of transferring the same. Thought this will be very useful for both learners and practitioners as well. Excerpt from How to Read a Financial Report: Wringing Vital Signs Out of the Numbers: John Tracy

Question for our Accounting/Finance MBA, CFA, CA Experts on the forum. If you could explain it this way, wouldn’t it be the smartest way of transferring Journal Entries - and what is at the heart of reading the interconnections in a Financial Report??

Your comments will spur me on to deep-dive again into trying another attempt at what I thought was beyond me :smile: to fully grasp

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@Donald
What this would additionally mean is :

  1. When someone fudges Sales Data, he will have to adjust Trade Receivables and its related cash flow. putting it in forensic terms --> If Sales Growth is not getting converted into Cash Flow from Operating Activity, it would mean something is amiss.

  2. Similarly one should always remeber that Accounts work on Double Entry. So you can fudge one data alone. Assuming Sales is Fudged --> It will flow into Balance Sheet Assets Side under Accounts Receivable --> So Assets side becomes higher --> Now to manage double entry --> You need to reduce some other figure in Asset Side --> Or increase some figure in Liability Side to bring both sides on par

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One should always follow the arrows pointed above…and keep questioning on how transaction is flowing.

Ultimately Cash Flow and Double Entry on Balance Sheet are classic forensic catchpoints.

  • If you charge fake numbers - Cash Flow wont tally

  • If you increase/decrease any number in Balance Sheet, you will have to match it back by adjusting some other figure

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@Donald
1)Blessing in Disguise :sunglasses: :
Finolex Sales Growth 3 Year :4.57 %
Pat Growth 3 Year: 3.73%
Stock Return over 3 Year : 300%
2)Low single digit Sales Growth leads to less infusion of fresh money for running business (Working Capital-WC).
Low Sales Growth -->Less Additional Money For Inventory & Accounts Receivables(Debtors)
3) Increase in Payable Days results in reduction in Cash Conversion Cycle ---->Reduction in %( WC/Sales)
Increase in Payable Days–>Use of suppliers money for running business @ 0% Net Interest :wink:
4)2 & 3 give boost to Operating Cash-flow
5)Boosted Operating Cash-flow used to deleverage balance sheet.
6)Reduction in Debt —>Lesser Interest Expenses ---->Increase in Net Income

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Thanks Vinamra,

Will check and revert. Assume this is Finolex Industries?
Back in station but again travelling for 3-4 days from tomorrow.

Find it hard to fit-in from my experience base though. There must be other reasons including margin expansion to aid this?

Yes this is Finolex Industries.
1)Gross Profit for last few year remain odd 33% .Except FY 15 it was 26.87% due to Inventory loss

Other manufacturing cost was reduced over 8.61 % to 4.31 %

2)Inventory days remain stable over last 4 years and marginal improvement in Receivable days.
Payable Days improve 53.84 % in FY 16 over FY 15

3)Cash Flow Statement FY 16

4)Use of Float ie…Other Peoples Money at 0 % interest

I am surprised how decrease in inventory and increase in payable days both happened incase of Finolex. This couldn’t be related to image Donald put in, where if there is an increase in inventory --> payables will increase.

Correct, if there is any misunderstanding

“”"“Low single digit Sales Growth leads to less infusion of fresh money for running business (Working Capital-WC.”""""

Actually, I have big disconnect on point # 2. Thinking from any entrepreneur s POV, he will do whatever it take to break the stagnant top line. That whatever primarily will be compromising on DSO thus be in need of additional cash.

In isolation something else may be going on for Finolex, however, in general, difficult to decipher if stagnant sales can be blessings, in whatsoever manner.

1)Cash Conversion Cycle : The cash conversion cycle is a metric used to gauge the effectiveness of a company’s management and, consequently, the overall health of that company. The calculation measures how fast a company can convert cash on hand into inventory and accounts payable, through sales and accounts receivable, and then back into cash.
Eg Finolex Industry

2)Cash Conversion Cycle =Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding

If there is no change in Days Inventory Outstanding, Days Sales Outstanding & Days Payable Outstanding then
increase in inventory --> payables will increase.
But if there is Increase in Days Payable Outstanding that will compensate for increase in inventory outstanding.

3)Days Inventory Outstanding : Average no of days inventory company hold their inventory (Raw Material , Work in Progress ,Finished Goods)

4)Days Sales Outstanding : Average number of days that a company takes to collect revenue after a sale has been made.

5) Days Payable Outstanding : Average number of days in which a company pays its suppliers.

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