Introduction to the Statement of Cash Flows

Alright now we're going to discuss the statement of cash flows. This is one of the tougher units in the course. So make sure to pay close attention. Let's start with an introduction. So the statement of cash flows. Remember we have our four main financial statements, we've dealt a lot with the balance sheet and the income statement, the statement of retained earnings or the statement of stockholders equity tells us the changes in stockholders equity or retained earnings. Right? And that's where we deal with dividends here. The statement of cash flows, it helps us get from our beginning cash balance to our ending cash balance right? We start we begin with some cash balance and then we're gonna have all sorts of additions to cash and subtractions to cash throughout the period that gets us to the ending cash balance. Right? So the statement of cash flows focuses on these additions and subtractions. What got us from the beginning cash to the ending cash. A lot of things happen in the cash account and we want to summarize them here with the cash flow statement. Okay, so why do we use the statement of cash flows? Well, first, it has predictive values. A lot of investors are interested in the cash flows of the company. From a financial perspective from finance perspective, they are definitely focused on cash flows. So a lot of investors focused on cash flows and the statement of cash flows is a great place for that information. It gives predictive value of future cash flows based on the past cash flows. How how's the company doing now? Well, that gives us the predictive value of what it's going to be doing in the future. It helps us evaluate management, right? Because we can evaluate how management uh uses cash flows, the cash that it brings into the business and how it uses it in the business. It determines the company's ability to pay right when we have to pay interest or pay dividends. Well, we need cash to do those transactions. So, the statement of cash flows is a good place to get information about that. And it, lastly, it gives us a little more information between the relationship of net income and cash flow. Remember that net income by itself is not a cash amount, right? Net income deals with revenues and expenses that are not always cash based. Sometimes we'll have a revenue that we don't receive the cash for it yet. Right. We'll have an account receivable for the future. Well, we want to make comparisons of that net income and cash flow. Maybe we have huge income, but not much cash flow coming in. Right. That could signify a problem. Okay, so that's the main reason why the statement of cash flow is important. Now, let's start discussing a little more details about the statement of cash flows itself. It's going to be organized into three main sections. Okay. We're gonna see three sections that we're going to become very familiar with throughout this chapter. So, the first section is the operating activities operating activities. This is where we deal with operations, right? The core business of the company. We want to see the cash flows that are generated through operations. So this these operating activities, they create revenues, expenses, the gains and losses, right? They deal with net income that comes from the income statement. Right? So we want to see this net income and the relationship it has the cash flow that comes from these operating activities. So like I said, it represents the core business and it's obvious that a successful business should be generating cash flows from operations. Right? We're in business to do this core business of ours. And if we can't generate positive cash flows, well, that's a red flag that we might go bankrupt in the future. So we must be generating positive cash flows to be a successful business. Maybe we'll have a period where we don't have operating cash flows. But in general we want to be seeing positive operating cash flows or it's just not gonna work. Okay, so when we talk about operating activities, we're gonna be focused on current assets and liabilities. Okay. When you think about our operations, were generally dealing with our current assets and current liabilities on our day to day basis. Right? And we're talking about specifically operating current assets and liabilities, right. When we think about operating current assets and liabilities, that's things like current assets. Excuse me, like accounts receivable inventory, right? Prepaid expenses, things that we use in our day, day to day operations or accounts payable and accrued expenses, right? These types of operating assets and liabilities. While these, these are the things that we deal with in our day to day operations. So our operating activities is generally dealing with that relationship between net income and operating cash flows. Cool. The next section. So notice we have three sections. This is the first section, arguably the most important section, because that's our core business. Then we have the investing section. So the investing section relates to the purchase and sale of long term assets. Okay, so this is when we're buying equipment or selling equipment for cash. Well, that's always gonna be an investing activity. We're gonna be dealing with our investments in long term assets as well as in long term investments. Maybe we buy some uh, equity or debt investment that we're gonna have for a long period of time. Well, that would be in the investing section. And remember, we're focused on cash. Right? This is the statement of cash flows. And finally, the third section is our financing activities. So we've got operating activities, investing activities, and financing activities. So notice we've talked about current assets and liabilities. We've talked about long term assets. Well, guess what? The financing activities? They deal with our investors and our creditors. And it's the rest of our balance sheet. So notice we're talking about our balance sheet here, right? The current assets and liabilities from our balance sheet, the long term assets from our balance sheet. And then the finance activities, they deal with our long term liabilities and our stockholders equity. So that's every part of our balance sheet is now being uh focused on through our cash flow statement. Okay, so now we're taking everything from a cash perspective on our cash flow statement. So, down here, I have a nice little summary of our our cash flow statement and how it relates to our balance sheet. We've got our operating cash flows, dealing with our current assets and current liabilities. We've got our investing cash flows, dealing with our long term assets. Right, do this in a different color. So operating cash flows, current assets and current liabilities. And then financing cash flows, deals with the long term liabilities and stockholders equity. So that deals with our entire balance sheet there. Okay, so that's gonna be the focus and we're gonna deal with each of these cash flows separately. We're gonna start with our operating cash flows. Then we'll get to the investing cash flows and the financing cash flows. Okay, so let's start with a little practice problem here and then I'm gonna show you a uh a cash flow statement on the next page

Alright. So I want to make one more note before I show you the statement of cash flows. And this is the supplemental disclosures at the bottom of the cash flow statement, we generally show a few extra things. So at the bottom here, at the bottom of the statement, we're going to explicitly tell the cash paid for interest and the cash paid for taxes. Sometimes that information gets a bit muddled inside the statement and we want to be very explicit, investors generally want this information. So we tell them explicitly the cash paid for interest and the cash paid for taxes that's not so important. Right now, I want to focus on these significant non cash investing and financing activities. So sometimes we'll have an uh, some big purchase that doesn't strictly touch cash. So an example would be if we purchased a building. Oops, we purchase a building, but we don't put any cash down and instead we sign a note payable. So notice this is a pretty significant transaction, right? We buy a building, let's say for $5 million and we sign a $5 million note payable. Well, there's no cash in this transaction and it wouldn't show up on the statement of cash flows. However, this is probably pretty important information to the investor. So we would make a supplemental disclosure at the bottom. We would say, hey, there was a purchase of a building in exchange for a note payable and there might be extra information about that transaction in the footnotes to the statements after we show the statements. Okay, so we'll talk more about significant non cash investing and financing activities in a separate lesson. But for now let's take a peek at an example of a cash flow statement, a statement of cash flows here. So the first thing I want to note is here at the top, it says for the year ended december 31st 2012. So remember this is for a period of time, it's not a snapshot. Which statement shows us a snapshot in time? The balance sheet, right? The balance sheet shows us at this moment how much cash is there? How much inventory is there? How much accounts payable? How much retained earnings, Right? It's at a point in time. But the all the other statements, our income statement, our statement of stockholders, equity or retained earnings and our statement of cash flows, they all show a period of time and that's exactly what we're dealing with here. We're gonna have some beginning balance of cash. We're gonna show all the changes to cash during the period and get to an ending balance of cash. Right? So notice how it starts here. It starts with our three sections. It shows us our operating section right here. So operating activities Do it in a different color green for cash. Okay, so the cash flow from operating activities and it shows we'll get into the details of how we calculate this, but it goes through the calculation and notice it deals with net income here because it's an operating activity. And we go through our our calculation and we get to a net cash flow from operating activities, right? So we have this net cash flow from operating activities of $50,000 in this example. And then it goes on to the next section, investing activities, right? Investing activities. And it shows different transactions from investments. And then it shows us our net cash flows from investing activities. And notice it's negative in this case. Right? That's okay. It's allowed to be negative. It's allowed to be positive. Well, we're just showing what happened, right? We this means that we had an outflow of cash, a net outflow of cash from our investing activities. And finally, we have our financing activities. So financing activities here, and it shows us our net cash flows from financing activities was again a negative amount. That means we had outflows from financing activities. This doesn't necessarily mean a good thing or a bad thing in any case, it's just showing you the information. So after we do our operating investing and financing activities, we get a sub total here. So this is the net increase or decrease in cash, which is the total of those three numbers. Right? This right here is the total of this, this And this over here. Right? So it's a total of those three numbers gets us the 14,000. And that's the change in cash during the period. And we take that change in cash and add it to the beginning amount of cash. So the 14,000 change in cash plus the beginning amount of cash. So this is the beginning of the period. This is the change in cash and this is the end of the period, right? If we take the beginning plus the change, well that gets us to the ending balance and this ending balance, this will be shown on the balance sheet. The balance sheet is going to show us actually both of these. It's gonna show us the beginning balance as last year's balance, right? Because when we show a balance sheet, we don't generally just show one year. We show last year as well, right? So it would show us the beginning balance as last year's balance. And then it would show us the ending balance as this year's balance. So the castro statement will show us the change from that beginning balance to that ending balance. And now notice here at the bottom, we've got a note, we're showing the non cash activities. So it says we purchased equipment by issuing a note payable in the amount of $20,000. So it's giving you that extra information about a non cash activity. Cool. Alright. So this is how the statement of cash flows is set up. You might want to go back and check this out after we've discussed each section in detail. Okay, so let's go ahead and start with the operating section in the next video.