Cash flow game (part 3): Difference between a cash flow statement and an Income Statement.

 

                        Source: internet, no intentions of copyright infringement

Many of you must have read my earlier income statement and balance sheet blog, The Cash Flow Game (parts 1 and 2). I am attaching a link below so you can refer to them as and when needed. Today, I'll explain the difference between a cash flow and an income statement. Vijay Shekhar Sharma(founder of Paytm) has said that what differentiates a company is its cash position or the cash flow, all the other factors without this are trash.

Cash flow game part 1...

Cash flow game part 2...

Indeed, studying through the cash flow game holds truth. To amass wealth, maintaining a robust cash flow is crucial for both individuals and businesses. Now, let's delve into the significance of these two potent terms: "Cash Flow."

When you sell your assets in order to raise cash for the purpose of purchasing other assets, this transaction is referred to as cash flow. For example, if you sell a piece of real estate in order to purchase another piece of real estate, these transactions typically incur minimal taxes or are tax-free compared to income. Additionally, using debt to acquire an asset also falls under the category of cash flow.

In a lecture, the investor Mohnish Pabrai gave an example of a company that had a few million dollars in profits but went on to buy two billion-dollar businesses with the help of debt or cash flow. So they had invested zero money in those businesses of their own. The terms of this agreement were negotiated so well that if banks couldn’t recover that money, they could seize those assets, so there was no direct threat to the company’s other assets. 

Earlier the interest rate on the asset was also high, yet they managed to make millions of dollars without putting a dime of their shareholders at risk. Later they re-financed that entire deal so their income increased. Re-finance means either they re-negotiated the interest rates or borrowed money from some other sources and paid back the principal with high rates. Looking at the income statement you couldn’t understand the two billion-dollar transactions until you looked at their cash flow statement.  

So how does the cash flow statement tell this story:
Cash from financing activities: +$2 billion (loan)
Cash from investing activities: -$2 billion

So the two billion dollars are added to the asset and the liability columns.

This will then be reflected in the income statement where you could see the income rising.

The primary lesson of this blog is to give this example that more income can be produced by companies and individuals without putting even a dime of theirs in the deal. Read and listen to Robert Kiyosaki where he explains how he creates deals with no equity, meaning no money of his own. This is why doing a cash flow analysis of the company is very essential while investing. 

Important note: Not every company and individual does that. It is a very personal way of investing. There are some obvious risks involved like the increase in interest rates. The terms of the debt are to be watched carefully and a thorough financial and risk analysis should be done.