Instructor for this course

Introduction to Statement of Cash Flows

Video Transcript:

"Hello, my name is Eric Slater and I will be showing you a little bit today about how to create a statement of cash flows. A little bit about myself before we start, I am a professor in the Ag Business Department 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 have been a professor for 13 or 14 years now, so this is a very enjoyable topic here, a statement of cash flows. Because it's one of those topics that you can get a lot out of, but it does take a little 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 some basic accounting knowledge.

If you feel like you need to bolster that a little bit, there's 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 bit vague for you.

Okay, so to jump in to our statement of cash flows 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 are we going to do?" We're going to talk about why the statement of cash flows is even important. I've got a little exercise that 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 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.

So, let's start with "What is a statement of cash flows?" So the statement of cash flows' main goal is to show you where a company got its cash, in other words, its 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 accural 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 accrual base accounting is to not worry about when the cash is spent so much. But instead to worry about when you earn the revenue and when you incur 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 did 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. I'm going to flip over to a different screen that has the same information, but it allows me to write on it and this way, I can kind of help draw your attention to what I want to show you.

So what we have here is two income statements for two companies. So we have company A and company B. And it's just obviously a very basic income statement. It has sales, expenses and net income. So we don't have any of the detail.

But we can see here that both companies are earning $500,000 of revenue of sales. They both have $425,000 of expenses. In other words, they both are earning $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. We'd say these guys are essentially equivalent companies.

We could even go a step further and look at the balance sheet and say
"Well, how much cash do these guys have?" And we could say "Well, at the beginning of the year, they both have $25,000 cash. And at the end of the year, they both have $25,000 cash." In other words, the amount of cash that they brought in is equal to the amount of cash that went out.

And 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 look at our cash received. And when you see it written this way where it says "Received" and then in brackets (Paid). What that means is "Received" is a positive number. "Paid" means negative number.

So if we see any negative numbers, it means an outflow of cash. And if we see positive numbers, we see an inflow of cash.

So now, we can start to see the information that would be coming from our statement of cash flows. It starts to describe maybe why these companies aren't so equivalent, even though everything up until this point looks equivalent.

Let's start with the cash received from customers. So company A received
$450,000 cash from customers and company B only received $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 they're saying "Yep, you can pay us later."

But company A is collecting almost all of their sales. There's only $50,000 worth of their sales they haven't collected that's sitting in accounts receivable, presumably. Whereas company B has $150,000 sitting in accounts receivable. The difference between the $500,000 in sales and the $350,000 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 the 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 kind of lets the money come in when it does?" So are there some management issues?

Continuing on, we see this next one. From sale of PP&E, Property, Plant And Equipment. So we're talking about fixed assets or equipment here.

So you can see company A pulled in $5,000 of cash from selling off 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 $60,000 cash from the sale of equipment.

So again, we don't know for sure what's happening. We'd 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.

So maybe company B had to sell off some equipment to get enough cash to run their business. Again, like I said, 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 they're not bringing in as much cash from it.

Okay, let's move on to the next line. Here we see "Cash paid," because it's negative number, so "Paid to suppliers." So again, their expenses were the same; $425,000 of expense. But company A is only paying out $380,000 whereas company B is paying off $400,000 of cash.

So again, like all of these, we'd 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 of managing its suppliers. And company A, 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're 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, Plant And Equipment. 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 $70,000 of cash on more equipment. Whereas company B only spent
$10,000 of cash 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, it's hard to say. But they only spent $10,000 of cash on new equipment. So obviously, not really investing in their future.

And then, the last item, it looks like company A had $5,000 available for purchasing investments. So maybe they put a little money into a subsidiary or they had some extra cash and they just wanted to invest it in the stock market or something like that. Where as company B, zero. They didn't have any cash available.

So we can see by looking at these statement of cash flow-type items, of cash received and cash paid, that it starts to paint a little different picture. Company A appears to maybe have a lot more going for it 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."


Course Syllabus
The 3 Sections
  11:32Sections of the Statement of Cash Flows
  8:56Operating Section
  6:46Operating and Investing Sections
  12:23Investing and Financing Sections; Completing the Statement of Cash Flows
Continuous Play
  50:23Introduction to Statement of Cash Flows
  PDFWork Sheet: Statement of Cash Flows
  XLSXCali Company .xlsx file (optional)
  PDFSlides: Statement of Cash Flows
  PDFStatement of Cash Flows Glossary/Index