Alright!
Here we are once again at mbabullshit.com.
So our topic for this video is free cash flow, ok, and sometimes also known as operating
cash flow, or OCF, or free cash flow, FCF, alright.
So, remember you can always go back to mbabullshit.com.
Alright, so let’s get down to it.
So, the focus of this video is to know, ok, is to know how financial managers prefer to
use a cash flow statement, ok, instead of a net income statement which is preferred
by accountant, alright.
Now, these two statements are very similar, but they are not exactly the same, alright.
So, you will see now in a while why they are not exactly the same, so, yeah, also, you
will also see why in order to make a cash flow statement you must first make a net income
statement, alright, so now, let’s get down to it.
So, as you remember from your accounting subject, if you did take accounting, ok, in the net
income statement you have to include the cash sales, meaning the sales for which you already
received cash plus you have to include the accrued sales.
Accrued sales means the sales which you made, but for which you still did not yet receive
the cash, so for example, if you earn a burger shop, or a car shop might be a better example
for this case, alright, if you sell a car today and you customer drives the car out
of your showroom, that is already considered a sale, ok, so even if your customer did not
yet pay you in cash, alright, even if he did not yet pay you in cash, ok, as soon as the
sale is made, or the sale is agreed upon, then it is already considered a sale, and
in accounting you already write that down here, ok, as part of your sales, and you include
that as part of your revenue in net income statement, and then also in the net income
statement, ok, we have to include the cost of sales, ok, and the expenses, right.
So, if you bought the car and you had to pay for, or you had to buy tires for the car,
you had to include that as part of your cost of sales.
Now, in accounting you will include both the case expenses and the accrued expenses, ok,
what are cash expenses?
Cash expenses means if you buy the tires, and you pay cash to your supplier, you include
that in the net income statement.
However, if you buy tires and you don’t pay the supplier yet, ok, alright, then those
are what you call accrued expenses, but you already write that down in the net income
statement already here, alright.
Now, another main thing which we include in the net income statement is our depreciation
expense, ok, so maybe in a car show room, you had to pay for, I don’t know, tables
and chairs, and you spent $1,000 on tables and chairs, and you expect the tables and
chairs to be useful for five years, ok, then you can say that there is a depreciation expense
of $200 a year for example, ok.
So, that is just an example.
It could be any amount.
The point is you have to include depreciation expense.
If you don’t fully understand depreciation, then I recommend that you go back to your
accounting subject, alright, and then after that we compute the net income before tax,
alright, so let’s try it right now.
Let’s say that you had state cash sales and accrued sales combined of $200.
Let’s say you had cost of sales, and cash expenses, and accrued expenses, and also accrued
cost of sales of $70, and you also had depreciation expense of $10.
We now can compute the net income before tax of $120, ok, so this is how much you earn
before tax, and this is considered your net income, so take note that this $120 some of
it is in cash maybe over here, and some of it might be accrued, meaning you did not get
the cash yet, alright.
Now, using your net income before tax, you now have to compute your tax, ok, so if we
assume, or pretend as an example, the tax is 35%, now remember, it might be a different
percentage in your exam, ok, it depends on your professor, but if taxes are 35%, well
then how much is 35% of $120?
It is $42, ok, so $42.
We subtract $42 that is why it is negative.
We subtract $42 from $120 and now we have our net income after tax and that is $78,
so here we have the net income after tax, and as far as accountants are concerned, this
is the most important part of the net income statement, right.
The reason why you make a net income statement is because you want to find out your net income
after tax, ok.
Now, very important, now, even though accountants think that this is the most important part
of the net income statement, ok, financial managers have a different view.
Financial managers usually, or quite often, do not care about this net income after tax,
ok.
Financial managers also like to make an income statement, but the reason they make an income
statement is so that they will know this amount, the tax amount.
Financial managers don’t care so much about this, about the net income after tax.
They care more about this part of the net income statement, and you will see why in
a short while as we go through the cash flow statement, alright, so let’s do that now.