Intro Video Transcript

Statement of Cash Flows – An Introduction By Erik Slayter Hello, My name is Erik Slayter, and I will be showing you a little bit about How to Create a Statement of Cash Flows. Little bit about myself before we start; I am a professor in the Ag Business Depart at Cal Poly, in San Luis Obispo, that’s one of California’s State University Schools, and San Luis Obispo is about halfway between Los Angeles and San Francisco, for those of you that aren’t so familiar with California geography. I’ve been a professor for 13-14 years now, so this is a very enjoyable topic here statement of cash flows because it’s one of those topics where you can get a lot out of but it does take a bit of work. We’re going to rely on some of your knowledge about how financial statements work, the balance sheet, the income statement in particular and we’re also going to rely on basic accounting knowledge. If you feel like you need to bolster that a little bit, there are some other sessions that I’ve done here on Performative that you might want to go back and look at those before you focus your time here, if some basic accounting concepts are maybe a little big for you. Okay so, to jump into our statement of cash flow session here, this is just an introduction, of course statement of cash flows can get much more complicated. We’re going to look at kind of a basic set, well, actually prepare a statement of cash flows as part of today’s session. So, let me show you the agenda: the agenda says here what we are going to do, we’re going to talk about why the Statement of Cash Flows is even important and I’ve got a little exercise we can do on that and then we’re going to talk about the sections of the Statement of Cash Flows, broken into three distinct sections, and we’re going to talk about what the indirect approach means as compared to the direct approach and then like I mentioned a moment ago, we’re going to do some hands-on, we’re going to get our hands dirty and prepare a Statement of Cash flows. Agenda: • What is the Statement of Cash Flows and why is it important? • Sections of the Statement of Cash Flows • Understanding the Indirect approach • Hands-On: Learn while preparing a Statement of Cash Flows So let’s start with: What is a Statement of Cash Flow? • Categorize the sources and uses of cash for a company • Different than an Income Statement – the Income Statement categorizes Revenues and Expenses • Not every revenue / expense is paired with cash • Not every event that involves cash is paired with revenue / expense So, the Statement of Cash Flows main goal is to show you where a company got its cash, in other words the sources and where it spent its cash, in other words the uses. If you think about the Income Statement; the Income Statement is saying “Where we earned our revenue and where we incurred our expenses.” But if you’re using a cruel basis accounting which any sizable company is going to do, then you have a situation where you don’t know what’s going on with your cash because the whole purpose of cruel base accounting is to not worry where the cash is spent so much, but instead to worry about when you earn the revenue and when you incurred the expense. So, in other words revenue and expenses aren’t necessarily paired with cash. You might pay for something in advance and get to use it later or you might do some work and get paid after the fact for it. So, what the Statement of Cash flows is trying to do for us, is show us where do we get our cash and where did we spend our cash. Let me show you a little example here of why the Statement of Cash flows is important. So, what we have here is two Income Statements for two companies. So, we have Company A and Company B and it’s just a very, very basic Income Statement • Sales • Expenses • Net Income Not many of the detail but we can see here that both companies are earning five hundred thousand dollars ($500,000) of revenue, of sales. They both have four hundred and twenty five thousand dollars ($425,000) of expenses, in other words they both are earning seventy five thousand dollars ($75,000) of Net Income. So, if all we looked at was an Income Statement, we would have no reason to believe that Company A and Company B have any differences right? We’d say “These guys are essentially equivalent companies.” We could even go a step further and look at the balance sheet and say “How much cash do these guys have?” and we could say “Well at the beginning of the year, they both have twenty five thousand dollars ($25,000) cash and at the end of the year they both have twenty five thousand dollars ($25,000) cash. In other words, the amount of cash that they brought in is equal to the amount of cash that went out. So, therefore, again we look at these two companies and they appear to be very similar right. Of course I’m setting you up here, there must be something different, so let’s jump down to this last section here where we looked at “Cash received” and when you see it written this way “received” and then in brackets (paid) What that means is; received is a positive number, paid means a negative number, so if we see any negative numbers it means outflow of cash and if we see positive numbers we see an inflow of cash, okay? So now we can start to see information that will be coming from our State of Cash Flows that starts to describe maybe why these aren’t so equivalent even though everything up until this point looks equivalent. Let’s start with cash received from customers. Okay, so, Company a received four hundred and fifty thousand dollars ($450,000) cash from customers, and Company B only three hundred and fifty thousand dollars ($350,000) cash from customers. So, even though they have the same amount of sales, they have a different amount of cash coming in. In other words, they’re selling on credit and saying “Yes, you can pay us later.” But Company A is collecting almost all of their sales, there’s only fifty thousand dollars ($50,000) worth of sales they haven’t collected that’s sitting in accounts receivable presumably. Whereas, company B has a hundred and fifty thousand dollars ($150,000) sitting in accounts receivable. The difference between the five hundred and sales and the three fifty of cash received from customers. So, what this is starting to point at is that Company A perhaps, we need to dig deeper but perhaps is doing a better job of collecting from their customers. So, the natural questions that maybe we would start to ask as managers would be, “Is Company A servicing their customers better, are their customers more willing to pay than the company B customers? Is it that Company A makes collection calls and does all the things to hassle their customers into paying and Company B just lets the money come in when it does, so, are there some manager issues? Okay so, continuing on, we see this next one from Sale of PP&E Property Plant and Equipment. Okay so, we’re talking about fixed assets or equipment here. So you can see Company A pulled in five thousand dollars ($5,000) of cash from selling of some old equipment, maybe they upgraded some equipment and they were able to sell some of the old stuff off, and Company B brought in sixty thousand dollars ($60,000) cash from the sale of equipment. So again, we don’t know for sure what’s happening, we need to dig deeper but on the face of this it looks to me like Company A is continuing to use their equipment and Company B is saying “Well, let’s maybe divest of some of this equipment, we don’t need quite the investment because maybe we’re not producing as much or something like that.” Okay, so maybe Company B had to sell off some of the equipment to get enough cash to run their business. Again, like I say, we have to dig deeper but it looks like something is going on here with the equipment and selling off this equipment, Company A is not selling as much or at least not bring in as much cash from it. Okay, let’s move onto the next line, here we see “Cash paid” because it’s a negative number, so paid to suppliers. So again, their expenses were the same four hundred and twenty five thousand dollars ($425,000) of expense. But, Company A is only paying out three hundred and eighty thousand ($380,000), whereas Company B is paying off four hundred thousand dollars ($400.000) cash. So again, like all of these we would have to dig deeper to know for sure but we could draw a couple of guesses. For example: maybe Company A is doing a better job at managing its suppliers and maybe they have a better relationship with their suppliers and they can stretch them a little bit further before they pay them. Maybe Company B is having some credit issues and they are going to have to pay for more stuff up front and not get granted credit. Those are a few of the things that maybe could be the situation here. If we go down a little bit further we can see “Purchases of Property Plan and Equipment (PP&E)” and again this is a negative number so cash paid for new equipment. Well, it looks like Company A is investing in their company they spent seventy thousand dollars of cash ($70,000) on more equipment. Whereas, Company B only spent ten thousand dollars of cash ($10,000) on new equipment, that would be an indication that perhaps Company A sees growth in their future and therefore is investing in more equipment to help be able to have the capacity for this growth. Whereas, Company B maybe they’d like to buy more equipment, maybe they don’t need to buy equipment, you know, it’s hard to say but they only spent ten thousand dollars ($10,000) of cash on their equipment so obviously not really investing in their future and now then the last item. It looks like Company A had five thousand dollars ($5,000) available for purchasing investments, so maybe they’re put a little money into subsidiary or maybe they had some extra cash and just wanted to invest it in the Stock Market or something like that. Whereas, Company B, zero (0) they didn’t have any cash available. So we can see by looking at these Statement of Cash Flow type items that cash received and cash paid is actually painting a different picture. Company A appears to maybe have a lot more going than Company B once we look at what’s going on with their cash. So, obviously this was a fabricated kind of situation here where Company A is made to look a lot better than Company B but hopefully it helps to illustrate the point.