hey everyone eric here in this video we're going to learn about what is the cash flow statement why
it's important and how to read one by walking through a real life example by the end of this
video you will feel confident interpreting cash flow statements on your own okay let's get started
so what is the purpose of the cash flow statement the main basic idea behind this
is that it tells us how much cash came into and left the company in the following ways
the first one is how much cash did the company generate from its core business meaning the thing
that it does so if it's a law firm how much money did it generate from its services and how much
money did it pay its employees the second way cash can come into and leave the company is where does
the company invest its own cash and the third way the cash can come in and leave the company is does
the company have outside investors because if so investors can be taking money from the company or
putting money into the company so with these three categories we get a great understanding of what is
happening with the cash inside of a company okay so in order to understand the cash flow statement
we need to understand that there are three main financial statements we use to understand
companies so the first is the income statement the income statement is a flow statement meaning
that it summarizes a period of time the income statement just tells us about our operations
so imagine we're a lemonade stand the income statement would tell us what was the revenue
from the lemonade we sold and how much should we pay for the lemons and the ingredients and
how much did we pay the employees what it would not tell us is when we bought the cart did we
take out a loan to buy the cart did our uncle invest in the company etc any of these sorts of
financing questions and investment questions you don't see it on the income statement so for that
we need to look at the balance sheet and the cash flow statement so the balance sheet is purely a
snapshot in a particular moment of what we own and what we owe nothing more it doesn't tell us about
the day before and it doesn't tell us about the day after and so the cash flow statement
is rather than being a snapshot it's also a flow statement it tells us about a period of time
but the cash flow statement tells us about the cash that came into the company
and the cash that went out of the company and this of course includes our operations like our
lemonade stand but it also includes things outside of the operations so any changes in what we
owe and what we own over periods of time so it converts the balance sheet into a flow statement
the cash flow statement itself doesn't tell us the specific operational details about the lemonade
stand but it tells us about financing it tells us about things we invested in and it gives us a good
overall picture of the capital situation of the business so the cash flow statement is organized
into three sections and these three sections tell you everything you need to know about cash the
first section is called operating activities this is the cash generated or used in the operations
of the company so this is just to deliver the core product or service the second section represents
the investing activities so anything the company is investing in any assets any acquisitions things
like this this is a big use of our cash and so we need to know what the company is buying
the third section is financing activities so these are any outside investments coming into
the company so this is debt raised or maybe we're paying off the debt any new equity raised anything
related to outside financing of the company is going to be a big source and use of cash for the
company and between these three you can get a full snapshot of where all the cash came from and where
all the cash went okay now that we got through the high level basics of the cash flow statement let's
look at a real example and practice interpreting the cash flow statement to try to understand
what is the overall financial health of a company and what do its operations look like first off if
you like this content please like this video now subscribe to my channel would really help me out
and i'll keep making content like this okay so this is a marketplace e-commerce company some sort
of online business that looks like amazon that hosts inventory and and sells online so you'll
see here on the cash flow statement that we have our three sections we have operating activities
then we have our investing activities and then we have our financing activities so let's look
at the business's operations first and this will tell us how much cash did the business
generate or use in its core operations and a lot of times they put starting cash at
the top so you have a reference point when you start seeing some of these cash metrics below
so we always start with net income because we're trying to take net income which is a non-cash
metric from the income statement and reconcile it so we can basically calculate how much actual cash
did we generate from the company so we start with net income and then we start adding back things
that are non-cash expenses because they didn't actually cost the company any money so first off
stock-based compensation that doesn't cost the company any money
we can just give that out for free so wherever we made that entry we're going to be adding it back
to net income because it was actually free from a cash standpoint also depreciation and amortization
this is something that we paid for in previous years and we're just making this entry on the p&l
based on the accrual based accounting standards so this is not cash out the door so now that we've
sort of reconciled net income to net cash you can see we actually generated here down below 4.2
million dollars of of cash flow but there's also some other things from our operations that would
increase or decrease our cash first off now we're looking at our operating assets and liabilities so
inventory what does this negative number represent it means that we built up our inventory and spent
cash doing it so that we can then sell it so this is actually a reduction in cash but on the
balance sheet you would see this is an increase in inventory then accounts receivable this again
is on the balance sheet an increase in people who say they're going to pay us in less than 30 days
but ultimately that's cash we did not collect so that reduces our cash flow accounts payable
this is an increase in the amount that we are supposed to pay other people within the next 30
days but we haven't paid yet so this is cash we've kept because we haven't paid it so this is cash
positive and finally deferred revenue is unearned revenue so it's basically people have paid us for
something and we haven't given it to them yet so we're sitting holding their cash waiting
to deliver the product or service so when we make all these adjustments to net income we see that in
the core operations of the business we generated 4.2 million dollars in cash from our operations
and in the subsequent years you see this number increasing based on the exact same calculations so
if we generated 4.2 million for operations where did we invest our cash because that's a
pretty significant cash flow i imagine that we're doing something with it so here in our investing
activities you can see some of the main categories you'll generally see investments in property and
equipment acquisitions of other companies and purchases and sales of many times like marketable
securities so some public liquid thing that trades like stocks or i don't know cryptocurrency or
whatever it would be so in 2021 you see that we paid 1.25 million dollars to buy new property
and equipment maybe this is a new warehouse or something like that we didn't make any
acquisitions and then we bought 125 000 dollars of securities and so 1.4 million dollars of cash
was used in investing activities in the company but in 2022 you see something more interesting
happen so we bought some property and equipment and you can see 12 million dollars went out of
the company this means that we made an acquisition a 12 million dollar acquisition of another company
and then we purchased some more securities so you can see we actually used 14 million but we
only generated six million dollars in cash so if we look at okay what was the final cash or what
was the starting cash of 2022 is only 8 million dollars so how did we do this well let's look down
below in the financing activities because this tells us how is the business financed what outside
equity or outside debt is coming into the company so that we can finance everything that we're doing
so we see in 2021 you see debt and typically you see proceeds so that's like debt that we
raised and then payments so that's debt that we're then paying off so that's cash out and
proceeds is cash in equity raise is cash in obviously so you see that in 2021 we actually
raised 2.5 million dollars so we would sold some percent of our company for 2.5 million dollars
that was a cash positive event in between our cash from operations the cash that we used in investing
and then the cash that we used or brought in from financing our overall net cash flow is 5.3
million dollars and so 5.3 plus our starting cash actually got us up to 8.5 million now if we go to
2022 when we made this acquisition you know we spent 14 million dollars where did it come from
here you can see we actually raised five million dollars of debt so we brought five million dollars
of new debt into the company along with the equity from the previous year and then we immediately
started paying our debt off say after we made this acquisition and you can see that our financing
brought in 4.34 million dollars into the company and that made it possible for us to make this 12
million dollar acquisition because net after all of our operations all of our investing and
all of our financing actually we we only reduced our cash by 3.8 million dollars
so that we finished the year with five million in cash and then in 2023 we would know this based on
our projections and our financial model that we go back to being positive so we're generating
7.4 million dollars from operations we're investing less than 2 million dollars in sort of
assets and things like this and then we're paying uh 1.4 million dollars off of the debt
so we generate a 4 million positive cash flow and our cash balance continues to go up we made
the acquisition and the company is healthy the last thing i want to talk about is free cash flow
i put in a note here that this is the king of all cash flow metrics
why so this isn't something that's typically on the cash flow statement but it's a metric you'll
hear a lot when people are analyzing big companies small companies any companies and this is because
the cash generated from your operations doesn't exist in a vacuum in order to operate your company
you need to invest in property equipment make acquisitions all this stuff
so when you take your operating cash flow you can't ignore the investments that are
critical to building your company so if you take your operating cash flow and you
subtract the cash that you used for investing then you have the real cash that the company has
left over and that is called your free cash flow and your free cash flow means you this cash flow
is free to do anything you want with it if you want to pay yourself a dividend if you want to
buy a thousand gallons of ice cream if you want to um you could do anything you want and as the owner
this is really if you if you have negative free cash flow you're in trouble maybe for one
year or another year you'll have negative free cash flow and that's okay but if your business
consistently does not generate positive free cash flow you're going to have a problem financing the
whole thing so sometimes companies can generate short term periods of negative
negative profitability or something like that but if your free cash flow looks good the company is
going to look great and tech companies that turn these sort of break-even net profit margins a lot
of times are doing this because they have these massive depreciations which can reduce the net
income and reduce the amount of taxes they have to pay companies like amazon but then they turn
these huge free cash flow margins which allow them to finance acquisitions of other businesses and
warehouses and offices and build their companies really really really fast so something to keep an
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finance skills okay that's all for today thanks for watching and i'll see you in the next video