What a set of accounts is for

A single number cannot describe a business, because a business raises three questions that have different shapes. Did we make money over this period? What do we own and owe right now? And where did the actual money go? The first two are not the same question, the third is not implied by either, and no one of them can be derived from the other two on its own.

So the accounts are three documents, not one, and they are designed to be read together. The habit worth building is not memorising line items. It is knowing which document to open, which is a decision you can make in about two seconds once you know that there are three.

• Income statement. Also called the P&L. Covers a period and answers whether the business made money over it. Session 2, and practitioner session 2.
• Balance sheet. A single moment, not a period. What the business owns and what it owes on one specific day. Practitioner session 5.
• Cash flow statement. Covers a period and answers where the money physically moved. Session 3, and practitioner session 4.
• Stock and flow. A stock is a level at a moment, like a bank balance. A flow is a movement over a period, like revenue. Confusing the two is the single most common misreading of accounts.
• Accrual. Recording revenue when it is earned rather than when it is collected. The reason profit and cash separate at all. Session 2.
• Working capital. The money tied up in unpaid customer invoices and unsold stock, less what the business has not yet paid its own suppliers. Practitioner session 3.
• Valuation. What a business is worth, which is a different subject with a different course. Not covered here.

Revenue, profit and cash generated are flows: they only mean something attached to a period. Cash in the bank, debt outstanding and stock on the shelf are levels: they only mean something attached to a date. A flow with no period and a level with no date are both unreadable, which is why "we made £52,781" and "we have £52,781" are completely different statements and are constantly confused in conversation.

The practical consequence is that a healthy flow and a dangerous level can coexist, which is exactly Marchmont's month 10. The profit flow was the strongest it had ever been. The cash level had been falling every month for nine months and finally went through zero. Asking "are we profitable" would have got a reassuring answer to a question nobody needed answered.

Three questions come up constantly in a review, and each has a home. Whether a product line earns its keep is an income statement question. Whether the business can survive the next quarter is a cash flow statement question. Whether it could borrow, and against what, is a balance sheet question.

Almost all of the confusion in finance conversations with non-finance people comes from a cash question being answered with a profit number, because the profit number is the one that gets circulated. It is not a trick: the profit number is genuinely the headline, it is just the headline for a different question.

Everything a business owns was funded by somebody: a lender, an owner, or profits it kept. So what it owns must equal what it owes plus what the owners have in it. That is not a convention chosen for tidiness, it is an accounting identity, and it holds at every moment or the books are wrong.

This makes the balance sheet a genuine error check rather than a report. A model of a business whose balance sheet does not balance has a mistake in it somewhere, and the failure to balance is how you find the mistake. Practitioner session 5 builds the check and then deliberately breaks it, because watching it fail is the fastest way to understand what it is testing.

Over those first twelve months Marchmont earned £445,631 of net income and generated minus £297,261 of free cash flow. The gap is £742,892, and it is not a rounding difference or a fraud. Of it, £664,607 is money sitting in unpaid customer invoices and unsold stock.

Marchmont sells to laboratories that pay on 75 day terms, and it holds two months of finished instruments so it can ship on request. Every extra pound of sales therefore arrives as a promise first and as money much later, while the wages and the materials that produced it are paid now. Growth makes this worse rather than better, which is session 4 and is the part that catches people out.

When somebody presents a profit figure, one question does most of the work: and what happened to cash over the same period? It is not a hostile question and it does not require any finance background to ask. If the two numbers move together, there is nothing to discuss. If they diverge, the reason is always interesting and is usually about timing rather than performance.

At Marchmont the honest answer in month 10 would have been that profit was the best it had ever been and cash was negative, because the business was funding its own growth out of its bank balance. That is a fundable situation and a survivable one. It is only dangerous when nobody says it out loud until the balance is gone.

A profit and cash gap is not automatically a warning sign. A business that is growing and sells on credit will always show one, and the absence of a gap in a fast growing company would itself be odd. What matters is whether the gap is understood, sized and funded, which is session 6.

Nor is it a valuation question. What Marchmont is worth, and whether anybody should buy it, uses different tools and is a different course. Nothing here is a view about whether any business is a good investment.