Accounting is the language of business. If you want to pick individual stocks
you must understand the three financial statements and how they relate to each other. In this video
we're going to give you a basic accounting lecture for how the income statement cash flow statement
and balance sheet are all correlated my name is brian feraldi my name is brian stoffel
thanks to quartr for sponsoring today's video brian let's start with a quick overview of what
the three financial statements are what is an income statement the main point of an income
statement is to show whether or not a company has a profit or a loss and that covers a certain
period of time whether it be one quarter of a year or a full year importantly an income statement
also uses accrual accounting which accounts for things like non-cash charges and it allows
you to realize revenue over a period of time instead of all at once a cash flow statement is
similar to the income statement in which it shows a business profit and loss but instead of doing
so on an accrual basis it actually shows you how cash moves in and out of a business during
that period of time and finally we have a balance sheet a balance sheet is a snapshot of a company's
net worth in other words on a particular day it balances the amount of assets that a company has
against its liabilities and its equity all right brian let's start by showing how the
income statement and the cash flow statement are connected to each other your end result from the
income statement the net income a company has it goes to the very top of the cash flow statement
all right let's start at the top of the income statement the first thing to look at is revenue
and revenue can be received as either cash or it can be received as accounts receivable and that
directly affects the company's working capital which is accounted for on the cash flow state
next let's look at the cost of goods sold the cost of goods sold represents the amount of money
you have to spend to create the service or the product that you're offering your customers now
when you do that that can have an obvious effect on changes in working capital most of the time it
can also affect non-cash charges because of stock based compensation however there are some times
where the cost of goods sold can be depreciated or amortized as well now after we have revenue
and we subtract cost of goods sold we end up with gross profit from there we have to subtract
all of the operating expenses that a business had during that period now those operating expenses
can be paid for with cash during the period or they can be non-cash expenses such as stock based
compensation depreciation or amortization they can also affect working capital with specifically the
accounts payable section next we need to account for the depreciation of capital expenditures and
when we do that counts as an operating expense now the next statement of the cash flow statement
is acquisitions and this one can be a little bit tricky at the time that an acquisition is
made it only affects the company's balance sheet it doesn't affect the income statement however
after the acquisition closes it does impact all areas of the income statement because the acquirer
gets to account for all the acquirey's revenue and expenses on their income statement moving forward
in addition later on if that acquisition has to be written down that can be accounted for as a
negative operating expense which would impact the income statement directly after we subtract out
all of those operating expenses from the gross profit we have our operating income but we're
not done yet we need to take out any interest expense that can be paid with cash but if it is
an accounts payable it would affect the changes in working capital in the cash flow statement
after we subtract the company's interest expense we get their pre-tax income but from there we
have to pay those income taxes and sometimes those taxes are paid with cash immediately other times
they also go as a taxes payable and that can also affect changes in working capital on the cash flow
statement all right now let's show how the income statement relates to the balance sheet first when
we get revenue from selling something that will affect two parts of the balance sheet the first
thing we have to do is account for any revenue that we have from sales now obviously if we make
a sale and we collect cash that will affect our cash and equivalents but we might sell something
and not receive payment for it right away if that's the case it goes under accounts receivable
after revenue comes cost of goods sold and the way that we paid for those costs of goods sold can
either affect cash if we pay for them with cash or they can affect the company's inventory next is
operating expenses and remember operating expenses is basically everything you need to pay for
to help your business run now that can obviously affect your cash and equivalence you might pre-pay
some of those expenses you might receive some of those things and not haven't paid them yet in
which case they'll end up in your payables or you might have to contribute to pension liabilities
for the people that are carrying out all these activities two other expenses that need to be
accounted for in some cases are depreciation and amortization and depending on the nature of those
expenses they can also take a hit to fixed assets or your intangible assets which are recorded on
the balance sheet next we need to account for any interest payments that you need to make obviously
if you make those right away that will affect your cash and equivalent eventually that will
also affect your levels of debt both short and long term or if it's a payment that you
need to make but you haven't yet it will affect your accounts payable next come your income tax
expenses if they were paid for with cash you have to subtract cash from the balance sheet if they
are made as a payable you have to increase that as a liability and finally after all this we arrive
at the net income whatever's left can make its way over to retained earnings on the balance sheet
next let's talk about how the balance sheet and the cash flow statement are related to each other
which is a really important connection but before we do that we wanted to give a shout out to this
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quarter for sponsoring today's video all right brian when we're talking about the cash flow
statement in the balance sheet the first and most important thing to know is what you arrive
at at the end of the cash flow statement is the amount of cash you have at the end of the period
obviously that number will go straight to the top of the balance sheet where cash and equivalents
are counted next we need to account for some non-cash charges that were recorded on the
income statement but need to be fixed on the cash flow statement that would include depreciation and
amortization which directly impact your fixed assets and your intangible assets after that we
need to account for changes in working capital obviously that will affect cash and equivalence
but it will also affect your accounts receivable and payable as well as your inventory next are
those pesky capital expenditures which is again things like property plant and equipment depending
on the nature of the way that we pay for those expenditures that can have a profound impact on
the balance sheet if we paid for them with cash obviously that subtracts from the cash balance
but it also increases the fixed asset balance conversely if we use debt to pay for them we would
have to increase either our short-term debt or our long-term debt depending on how we paid for them
if you think capex was pesky let's talk about acquisitions when you make an acquisition you
need to pay for it so that's obviously going to affect both your cash and your debt whether it's
long-term or short-term debt you likely also paid a little bit above the asking price for
the company to get them to agree to be acquired that counts as goodwill which is accounted for
an intangible asset and once you close on the acquisition you're going to own all the things
that the previous company owned which changes your fixed assets the next section in the investing
activities is when you get proceeds from selling an asset and depending on how you sold that
asset that can either increase your cash balance increase your receivable balance but it will also
decrease your fixed assets and your intangible asset let's say that you either decided to
borrow more money and take on debt or repay some of that debt that is going to affect the amount of
cash you have and it will affect your debt levels both short and long term how about if during that
period you bought back or issued shares of stock that's going to directly affect both your cash
balance as well as your treasury stock and your additional paid in capital balances or let's say
you're one of those more mature companies that can afford to pay out dividends when you pay out
that dividend it reduces the amount of cash you have and it affects the retained earnings the
company has i realized we just threw a whole bunch of information your way so in that case
it can be helpful to look at very basic examples to see how the income statement
cash flow statement and balance sheet are all correlated to each other if you haven't watched
our detailed videos on those three statements please go and check those out now because the
numbers you're going to see on your screen are going to make a whole lot more sense then at the
end of last year's farmer's market this is where our little coffee stand stood we've included the
income balance and cash flow statements for you to see if we start by looking at the income statement
and go from the top down you can see how every line item here impacts directly in the balance
sheet if you want a more detailed look at this just pause the screen next if we want to see the
interplay between the balance sheet and the cash flow statement we see that many of the assets have
some type of effect on changes in working capital payables also played a very small role in the
changes in working capital as well finally here's a look at how the investing activities and finance
activities from the cash flow statement directly impacted the balance sheet getting to know all the
details of the financial statements can be a bit of a bear and that's where books can be helpful
if you're interested in diving deeper into this subject we highly recommend the three books
that you see on your screen brian i think it's important to wrap up by saying that we can't teach
the intricacies of all three of these statements and how they relate to each other perfectly
this is something that you need to practice and as you do practice it will become intuitive for
you what the dynamics are between these three really important financial statements the good
news for investors is that all these interplays between three financial statements is handled
for us by the accounting team of the company that's presenting the information still it's
really important for investors to know how these numbers impact each other so that when you're
reviewing the statements you can make informed decisions we hope this was helpful brian's out