Welcome to Finance in Excel video number 84.
Hey, if you want to download this workbook for chapter 9,
click on the link directly below the video
and scroll all the way down to the Finance Excel class
section.
Hey, in this video here, we have to talk about the intersection
of accounting and finance because finance people are
trying to get at cash flows.
And accountants record accounting
with accrual accounting.
Now, accrual accounting means if a sale is recorded,
it's recorded because it's earned.
If an expense is recorded, it's recorded because it's incurred.
It doesn't matter if the cash moved or not.
So in this example here, we have a sale.
And we credit it, which means increase.
So that's great.
We have a revenue on the income statement, $100 plus.
But the person's not paying cash right now.
They promised to pay 30 days later.
So there's an accounts receivable.
Accounts receivable is just a holding tank
until the cash comes in later.
So there's a revenue on the income
statement without any cash.
Similarly, we have this cost of goods sold.
So we have to-- at the time of sale, we recorded the sale.
But we also recorded the associated expense.
But there's no cash associated with this either.
Also there's an inventory here.
When we're talking about accrual accounting,
we have a revenue, an expense.
We are also talking about current assets, accounts
receivable, and a current assets inventory.
Down here, we're talking about an expense
and a current liability.
So here we recorded the expense.
But there's no cash going out.
We don't see a credit to cash.
It's to account payable.
That's us promising to pay cash later.
Now we want to take a look at how this impacts our cash flow
analysis.
This class isn't really about undoing accrual accounting.
But we'll just take a little snapshot here
and look at a simple example to at least get the idea.
So here's the situation.
We have sales of $1,000, total costs fixed
and variable of $800.
And so the difference between those is $200.
Well, if there are some non-cash revenues
and some non-cash expenses, then the gross profit
would be a little bit different than this.
All right, here's our balance sheet begin and balance
sheet end.
Let's just think about accounts receivable.
Accounts receivable-- it started at $200 and it went up.
So at the end of the year, we have more accounts receivable.
That means there's some revenue in our income statement, right,
that $1,000 right there, that has no cash associated with it.
So when accounts receivable goes up,
we actually need to take that and subtract it.
So if we look down here, we need to remove that accounts
receivable from the sale.
Sales were recorded on the income statement
with no associated cash.
So really we do whatever calculation.
But it's a minus.
I have to take that out.
So we have to take a minus out of that amount.
Now inventory-- inventory we started at 100
and we went down, down to 90.
Well, if inventory went down, that
means we sold more inventory than we bought this period.
So that means there's an expense right here somewhere
that shouldn't be there.
So if we have an expense, which is
a subtraction that shouldn't be there,
we need to add it back in.
So add back inventory decrease to cost of goods sold expense.
Expenses were recorded on the income statement
with no cash out.
So really we want a positive here.
We have to add it back.
Finally, let's look at accounts payable, right?
Accounts payable is we owe.
But it went down.
It started at $200 and went down to $180.
That means we paid out some cash that has no associated expense
up here.
So if we paid out cash--
that's cash going out--
and there's nothing up in the income statement,
we have to subtract it out.
We have to remove account payable decrease from expenses.
Cash went out with no associated expense
on the income statement.
So however you do it, it is a minus.
So 180 minus that.
Now let's just add this up, right?
It's minus 30.
So we need a total of $30 adjustment in whatever revenues
and expenses we have there.
This is our balance sheet.
We have to subtract $30.
In essence, there's $30 too much on our income statement.
Now let's just notice something.
In this class, we're not doing any of this undoing
of accrual accounting.
They're just saying take the difference between net working
capital at the end and the begin.
Well, let's go ahead and calculate that.
Here's the begin.
Here's the end.
So equals this plus this-- those are the assets in this case.
These are the only two assets and the only
current liability-- current assets and current liabilities.
And we subtract that.
So our formula for networking capital
is all the current assets minus all the current liabilities.
These are the only ones we have, so that's our calculation.
Now I'm going to copy this over.
And lo and behold, back in chapter 2 and in this chapter,
the calculation we make is end networking capital,
the change between them, right?
End minus begin.
Now we get a positive 30, which is OK because look at this.
What is our formula?
Total cash flow-- in our last video,
we saw operating cash flow.
And we had to subtract out the net working capital
minus any capital spending.
And this goes back to chapter 2 also.
So even though we calculated as a change here
because we're doing the blunt method--
we're just looking at all of networking capital--
there was a change of 30, right?
And so we had to subtract it.
But look at this.
If we do the individual transactions
or the individual accounts really here,
we see that we get a subtraction of 30,
which means we have too much--
we have $30 too much up in the income statement.
Now, here's how we do it in this class.
We say adjustment to operating cash flow.
So if this is our operating cash flows, for this exa--
the example we're doing, we say operating cash flow.
And we just minus.
And whatever the change is--
so I'm going to say 130 minus 100, we get 140.
But if we had done it our undo accrual accounting way,
we would've said 170 plus this minus 30 because we had too--
that means we have operating cash flow was stated--
overstated by $30 because of accrual accounting.
All right, in our next video, I think
we're going to do a MACRS depreciation to see
the relevant depreciation cash flows in regard to taxes.
All right, see you next video.