Hi-- Else here.
Many external stakeholders say cash
is king, a critical part of making informed decisions
and therefore an important part of the financial statements.
So for this video, we'll be developing
the statement of cash flows.
First, let's remind ourselves about
the other financial statements and their interconnections.
The income statement shows the profitability of a business.
It shows the revenues and expenses over a period of time.
The profit at the bottom of the statement-- or loss if expenses
are greater than revenues-- is used in the statement
of retained earnings.
The statement of retained earnings
shows how much of the profit is kept
in the business for future growth and expansion.
It adds the profit or deducts the losses taken
from the income statement to the opening
retained earnings from the prior year.
After subtracting dividends, the resulting number
is transferred to the equity section of the balance sheet.
The balance sheet tells the story
of a business, its financial position.
It is divided into assets, both current and long-term.
These are owned by the business.
Notice that the long-term assets are subdivided into intangibles
and other assets.
It also shows the current and long-term liabilities which
are owed to third parties.
Finally, it shows the equity which is owed to the owners.
As you can see, the closing balance
on the statement of retained earnings
is used in the equity section of the balance sheet.
How is the balance sheet connected
to the statement of cash flows?
It is clear that we need profit from the income statement
to get retained earnings and retained earnings
from the statement of retained earnings
to get the equity on the balance sheet.
Each statement creates a number for the next statement
and without that number, the statement cannot be completed.
But all the numbers are complete now.
Nothing is missing.
So how does the statement of cash flow tie in?
The statement of cash flow does not create a number.
Instead, it explains how the business ended up
with the cash balance that is on the balance sheet.
Cash flow statements show the company's management
of cash, what cash has been received or paid
over a period of time.
It uses the cash basis of accounting.
That means the statement shows only those activities that
result in a change in cash.
It ignores all activities that do not involve cash.
For instance, if services are sold on account,
the cash flow statement would not report it.
Why not?
Because it did not involve cash--
when you look at the statement of cash flows,
you are looking at something similar to a bank
account, which shows only when the cash flows in
and when it flows out.
To help provide information about what causes the inflow
or outflow, the statement is divided
into activities, financing, investing, and operating.
Let's see how much you remember about the video on business
activities.
Pause this video and answer the question
before I answer it for you.
"The payment of dividends is considered"--
the answer is not A because the payment of dividends is not
part of the day-to-day activities of a business so it
does not belong in operating activities.
The answer is not B. Investing activities are all
about buying and selling long-lived assets,
both tangible and intangible.
Dividends are not a long-lived asset.
If the answer is not A or B, then the answer certainly
can't be D or E, either.
The correct answer is C, financing activities.
Remember that financing activities include
contributions by owners.
Dividends are the paying out of profit to the owners
so it belongs in the same category as the funding does.
Let's move on to the statement of cash flows.
As always, the statement starts with the business name,
followed by the name of the statement.
Notice that this name is the "Statement of Cash Flows,"
not "the cash flow statement."
Then the date-- notice like the income statement
and the statement of retained earnings,
the statement of cash flows is for a period of time
and the date reflects that.
We start with the heading "Operating activities."
Any of the day-to-day activities that
cause an inflow or outflow of cash is listed here.
We can see that sales to customers resulted in a $91,760
inflow of cash but payments to suppliers
caused an outflow of cash of $63,796.
Notice that the outflows are placed in
brackets to indicate the fact that they are outflows.
Both inflows and outflows are listed separately
and the description clearly indicates
the reason why it happened.
This section closes with the total for this activity.
Note something important.
If the overall result of the activity is an inflow of cash,
as it is here, we use the word "provided" in the subtotal.
However, if the result is an outflow of cash,
the word "used" would have been there instead.
Next, the heading "Investing activities"--
this section is made up of the cash flows from the purchase
and sale of long-lived assets, both tangible, like a building,
and intangible, like the paying for the design of a website.
Each is listed individually with a description.
This is followed by a subtotal to show the inflow
or as in this case, the outflow of cash due to the investing
activities.
Again, notice the word "used" to indicate
that this activity resulted in an overall outflow of cash.
The last section has the heading "Financing activities."
This section shows the inflows and outflows
due to funding activities, such as an inflow from the owners'
contributing capital or an outflow
due to the payment of cash dividends to the owners.
Each inflow or outflow is listed individually,
followed by a subtotal for the financing activities.
Yet again, the word "provided" indicates that this activity
had an overall inflow of cash.
We have completed the listing of inflows and outflows
by activity.
So next, we have to have a net increase, as in this case,
or decrease in cash.
How is this number determined?
We take the subtotal of the operating, investing,
and financing activities and add or subtract them
as required to get a total or net change in cash.
Because the statement has been divided into different slides,
this is difficult to see, which is
why I'm showing you how the net increase for cash of $51,110
has been determined here on this slide.
On the statement of cash flows, the net change in cash
is placed immediately under the subtotal
for financing activities.
Notice that the subtotal must indicate
if the business's overall cash position has increased,
as is the case here, or decreased their cash position.
In this case, the business's cash position increased
but what does that mean?
Nothing until you add it to the opening cash
balance from the current year.
Where does this number come from?
The opening cash balance from this current year
is equal to the closing balance from the prior year's balance
sheet.
Remember, this statement is showing
how cash changed between the beginning of the year
and the end of the year so we must
start with the cash at the beginning of the year.
Add or deduct the changes to get the cash
at the end of the year.
Notice that the cash balance at the end of the year
is equal to the cash balance on the balance sheet in the cash
account listed under current assets.
You can see that clearly if we flip back to the Current Assets
section of the balance sheet.
The cash balance in the cash account is exactly the same.
We have now explained how the cash balance changed over time
using the three business activities.
Let's take a final look at the whole statement of cash flows.
We started with the title, then listed
the operating activities with a subtotal
and the investing activities with a subtotal
and finally, the financing activities with a subtotal.
By adding all the subtotals of each activity together,
we determined the net change in cash.
Add or deduct it from the opening cash balance
to get the closing cash balance for the current year.
Let's check your understanding of the statement of cash flows.
Remember to pause the video before listening to my answer.
The president of your business says
there has been an overall increase in the cash balance
over the last year and the business is doing well.
You check the statement of cash flows
and find that there has been an outflow under operating
activities and an inflow from both investing and financing.
Do you agree with the president's statement
that the business has done well?
The answer is B, absolutely not.
Businesses after the first few years
should see an inflow from operating activities.
Operations is where the business should be making their money.
Sure, a business might sell some equipment,
resulting in an inflow from investing activities.
Or they could borrow money so they'd get an inflow
from financing activities.
But the main source of cash from any business
should be through their day-to-day operations
and that's demonstrated through the operating activities.
If you can't make money by running your business,
how long will the bank be willing to lend you money?
Not very long.
What is the statement of cash flows used for?
Owners use it to determine if there is enough cash
to pay out dividends.
Lenders and creditors will use it to determine if the business
debts can be paid as they come due
or if the business will need to borrow more cash.
Finally, everyone uses this statement
to predict future cash flows.
That helps them to make informed decisions.
The cash flow was the last statement
in our series of videos on the financial statements.
Thank you for joining me.
I hope these videos have helped you
to learn all about the structure and interconnection
between the four financial statements.