Hi.
Else here.
And in this video, we'll be exploring the statement
of cash flows under ASPE.
The statement of cash flows is a last financial statement.
Although we still have the notes to the financial statements
to cover, they are not a statement,
but an important supplement to the statements.
Understanding the interconnection
between the statements is critical
when developing the statements.
In the balance sheet video, I demonstrated
the interconnection between the various statements using
slides.
Today, to show you a different view,
I'm going to use a matrix.
In the far left column, you see the statement name
and the amount that is carried to an other statement.
If you follow the row to your right,
you see which statement this amount is carried to.
Let's focus on just one row as an example.
Here you can see that the net income or net loss
amount from the income statement is added or deducted
from the opening retained earnings
on the statement of retained earnings.
In addition, it is used as the opening number for operating
activities in the statement of cash flows,
under the indirect method.
You can also see very quickly that the net income or net loss
is never used directly in the balance sheet.
By using a matrix, you can quickly
see the interconnection between different financial statements.
Let's go back to the full matrix and focus on the last row.
It shows that the cash balance from the current asset
section of the balance sheet is used as the closing cash
on the statement of cash flows.
If you look at the last column in the matrix,
you see that the two statements which
are interconnected with the statement of cash flows--
the net income or net loss from the income statement
and the closing cash balance from the balance sheet.
Consider using a matrix when you can,
as it's a very good visual representation
of the connection between the financial statements.
The statement of cash flows is divided into three activities--
operating, investing, and financing.
Descriptions of each of these activities
has already been covered in a previous video,
but let's just review them quickly.
Financing is activities that fund the company,
either through debt or equity.
Investing is activities that result from buying and selling
property, plant, and equipment, intangibles, or investments.
Operating is the activities that a company
does every day, selling or delivering goods or services.
To obtain an in-depth understanding
of these activities, please see my video
on business activities.
The statement of cash flows can be
prepared using the direct or indirect method.
There is no difference between the direct and indirect method
for both the investing and financing activities section
of the cash flow.
Under both methods, these two activities
are exactly the same.
That is not true, however, for operating activities.
The direct method lists the inflows and outflows
for each type of operating activity a company performs.
Cash flow categories shown include
cash collected from customers, cash paid to suppliers,
and cash paid to employees, just to list a few.
This method is considered more informative for stakeholders
and their decision making, because it clearly
shows the sources and uses of cash from operations.
The indirect method focuses on the differences
between net income under accrue accounting and cash
from operating activities under cash accounting.
It starts with net income and adjusts for non-cash items,
such as adding back depreciation expense
or deducting a decrease in accounts payable.
The indirect method is more difficult for users
to understand.
But that does not stop approximately 98%
of all US, European, and Canadian companies
from using the indirect method to calculate cash flows
from operating activities.
Why?
Because it is easier and less costly to prepare.
Are there any benefits for stakeholders
who use the statement of cash flows to assess a business?
Yes.
One benefit for stakeholders is that the indirect method may
highlight earnings management.
How?
By highlighting the difference between net income and cash
flows from operations.
We will further explore this concept
when we cover the development of cash flow
statements in a later video.
Considering the popularity of the indirect method
for the development of the statement of cash flows,
we'll be using the statement of cash
flows indirect method for purposes of these videos.
I will, however, also quickly show
you the direct method for comparison purposes.
Let's do a quick check of your understanding so far.
The payment of interest on a long-term loan is considered--
the answer is definitely not D. All cash outflows are included
on the statement of cash flows.
The answer is not B, investing activities.
Debt is never part of investments.
The answer is not C either.
Even though debt is part of financing activities,
interest paid on debt is on the income statement,
as an expense.
An income statement is the accrual accounting view
of the operating activities.
ASPE requires that it remain as part of operating activities.
The answer is therefore A, an operating activity.
An in-depth explanation of this will
be provided in a future video.
Now that we understand the activities that
make up the statement of cash flows,
we can look at an example.
Note that this statement is so large
that I've divided it into two slides,
so that you can see each activity better.
But the statement is actually one statement,
with the three activities listed immediately after each other.
Although I have set up the statement in columns
for easy viewing, the accounts can all
be listed in one column and the amounts in another.
As always, the statement starts with a heading,
which must include the company name,
the title of the financial statement,
and the period of time covered.
Note, similar to the income statement and the statement
of retained earnings, this statement
is for a period of time, most commonly one year.
The statement opens with the heading for operating
activities and then starts with net income
from the income statement.
All the other amounts are reconciling
items between net income from the income statement, which,
remember, uses accrual accounting,
and the cash flow from operations,
which uses cash accounting.
These items are known as non-cash items.
This includes things such as depreciation and the change
in current assets and liability accounts
from the balance sheet.
Again, an in-depth explanation of these adjustments
will be made in a future video.
For now, what's important is to simply understand
the structure of the statement and why
it is required under ASPE.
At the bottom of this section, we
see that operating activities resulted in a net cash
inflow of $21,400.
Investing activities are next.
You'll note there's a net cash outflow
of $7,500 due to the purchase of both equipment and investments.
A cash outflow from investing activities
is not unusual, because it means that the business is investing
in the future ability to generate revenue.
And that's a positive thing for investors and creditors.
Finally, let's look at the financing activities.
Here, we see that the owners of the business
contributed more cash to the business
and that the business paid down some of their debt.
We can also see that the business paid out dividends
to the owners.
This ties into the $2,500 we saw in the statement
of retained earnings as a dividend paid during the year.
A subtotal of the financing activities is then seen.
The bottom of the cash flow statement
shows the net change in cash.
How is this calculated?
This is a summation of all three activities.
For this cash flow, that would be the operating inflow
of 21,400, investing and financing outflows of 7,500
and 1,700, respectively.
This results in a change in cash during the year
of $12,200, an inflow.
This amount is noted on the cash flow statement.
We then add this to the beginning balance of 72,300,
which we obtain from the prior year's balance sheet.
Remember that the closing cash from one period
becomes the opening balance for the next period.
Adding the change in cash to the cash
from the start of the year, we get an ending cash balance
of 84,500.
What does this tie into from the other financial statements?
This is the cash balance on the balance sheet,
under current assets for the current year.
We can clearly see the interconnection
between the balance sheet and the statement of cash flows.
Let's take a quick look at the statement of cash flows again.
Remember, we start with the appropriate headings
and net income from the income statement.
We move on to the operating activities,
than the investing activities, with the financing activities
listed last.
The net change in cash is then added, net increase,
as demonstrated here, or deducted
if it is a net decrease, from the opening cash balance.
This will obtain the closing cash
balance, which is on the balance sheet under current assets.
Now, let's quickly see the structure
of the statement of cash flows when we
use the direct method instead.
Noticed that the operating activities do not
include net income or any reconciling items.
Instead, the information provided
us focuses on where cash was received or paid.
This provides better information for stakeholders to analyze
and, for that reason, is preferred
by ASPE, although not required.
Remember that 98% of all companies
use the indirect method.
The investing activities and the financing activities
under the direct method are exactly
the same as what you saw under the indirect method.
Let's check your understanding for a second.
Remember to pause the video to determine your own answer
before continuing.
Net income is $17,100, but the cash flow from operating
activities is 21,400.
Why is there a difference?
The answer is not E. One of the above answers is correct.
The answer is not D. The question specifically
says there is a difference between net income
and operating activities only.
So this answer does not apply.
The answer is not C. The statement of cash flows,
as its name implies, uses the cash basis of accounting,
not the accrual basis.
The answer is not A. The income statement
uses the accrual basis of accounting, not the cash basis.
The answer is B, because the income statement uses
the accrual basis of accounting, and the cash flow
from operation uses the cash basis of accounting.
There will always be a difference
between net income and cash flow from operating activities.
So what questions does the statement of cash answer?
For investors, it helps to determine, in conjunction
with the income statement, if there
will be enough cash in the future to pay dividends.
For lenders and other creditors, it
helps determine if there is cash available
to pay the debts of the company as they come due.
It also helps them determine if the company will
need further financing in the future.
Finally, all external stakeholders
will use the cash flow statement with the income statement
to help predict future cash flows.
We have now completed all the financial statements
under ASPE.
But there is an important addition
to the statements, which we have not
covered, the notes that accompany
the financial statements.
And that will be the topic of our next video.