 Hello and welcome to this session. This is Professor Farhad. In this session, we would look at an introduction to the statement of cash flows. This topic is covered in an introductory accounting course, intermediate accounting, as well as the CPA exam, the FAR section. As always, I would like to remind you to connect with me only then if you haven't done so. YouTube is where you would need to subscribe. I have 1700 plus accounting, auditing, finance and tax lectures. This is a list of all the courses that I cover. If you like my recording, please like them, share them. It doesn't cost you anything. Subscribe. If they benefit you, it means they might benefit other people. Share the wealth, especially during those coronavirus days. Follow me on Instagram. On my website, you will find additional resources to supplement your accounting education and or pass your CPA exam. If you're looking for those 10 to 15 extra points to pass the CPA exam, I'm here to help you check out my website. So the first thing we're going to talk about is the purpose of the statement of cash flows. What is the purpose of it? So from a business perspective, if you're an analyst, if you are a user of this financial statement, what is the purpose of it? Well, it tells us how does a company receive its cash. So we have cash coming in. How? How are we getting this cash? Is it from sales? Is it from common stock? Is it from that? Where is the cash coming from? That's important. And the cash flow statement clearly shows us where is this cash coming from. Also, why do income and cash flow differs? What do I mean by this? When you prepare the income statement, you come up with a number called net income or net loss for that purpose. Then the statement of cash flow, it's going to tell us how much of that net income is actually cash. Well, remember, the income statement uses the cruel accounting. The cash flow uses cash accounting. So it's going to convert the accrual to cash. Then it's going to tell you whether or not on a cash basis, you are making money, not only on an accrual basis, on a cash basis. It's also going to explain the change in the cash balance. So how much cash did I have last period versus this period? And this is the whole purpose, is to explain the change in cash. And by explaining the change in cash, we're going to break it down into separate categories to determine what happened to our cash from one period to the other. And obviously it's going to tell us where are we spending the cash? Who are we paying for our cash? Are we spending it on employees, on supplies, on paying debt, on buying back our own stock? Where's the cash going? So where are we spending our cash? So it practically answers a lot of important questions. And that's why it's a very important financial statement in the real world. So it helps users decide whether the company has enough cash to pay its debt. So before you lend money to the company, the first thing you do is you look at your cash flow. Do they have enough cash to pay me back? That's a big question. Well, we'll tell us whether the company's ability to pursue unexpected opportunities. Do we have extra cash? Or what we called free flow of cash? Do we have that free flow of cash in case an opportunity presented itself? Do we have cash to take advantage of it? Okay. Managers plan day-to-day operation. Well, having a statement of cash flow, it's going to help managers determine how much cash that's coming, how much cash we are spending. So we make sure we don't run out of cash in our day-to-day operation. And also for long-term investments, we need cash because when we buy property, plant and equipment, those are long-term investments. Do we have enough cash to comply or not to comply to reach our purpose, to reach our goal in terms of long-term investments? Now how do we measure cash? So what is actually considered cash as far as cash? Well, obviously cash is, if you have actual cash, we are all familiar with cash, paper cash, coins, checking accounts, savings account, all sorts of things. Now in addition to cash itself, we could have short-term, highly liquid investments like what? Like Treasury Bond. If we lend money to the government, if we lend money to the government, what's going to happen? That's not considered cash. That's considered cash equivalent because cash is easy. Here's cash. We can always see, touch, see the cash. But there are something called cash equivalent. And what are cash equivalent? Well, long-term Treasury Bond, short-term Treasury Bond actually, certificate of deposit, CD at the bank. Those are cash equivalent. So how do we define something cash equivalent? Short-term usually less than 90 days. Highly liquid, it means they can be converted to cash very quickly. They are readily convertible to cash, and they are so close to maturity that the market value does not fluctuate. In other words, the changes in interest rate don't affect the CD, don't affect Treasury Bond. Why? Because they have a short-term maturity, 90 days, and they will mature, so it's not a big deal. So when we say cash, what we mean is cash plus cash equivalent. So cash plus cash equivalent is what we are looking for the change. Now, the statement of cash flow, classify the changes in cash into three categories, and we're going to be looking under those three categories in detail. We're going to devote a lecture for each of these categories. In this session, I'm going to give you an overview over each category. One is operating activities, two investing activities, three financing activities. And what I'm going to do, I'm going to explain each one of those separately in this session. Then the next session I will devote one section about operating activities, another section about investing, and a third section about financing. And maybe I will work an example that combine all those three sections together, starting with operating activities. So to illustrate or to make the point, I'm going to assume we're going to be dealing with a restaurant business. So but take this restaurant business and illustrate this concept to any business you can think of. When we think of operating activities, think of the word operating. When you operate your business, what do you do? Well, let's look at a restaurant. When you operate your business, you need employees, you need supplies, I'm sorry, you need the goods to serve the customers, you need supplies, right? You need all sorts of, let's start by looking at operating activities. And from the word operating, what should you be thinking of? How do we operate the business? Well, how do we operate the business? Well, think of a restaurant. If we're dealing with the restaurant, you need employees to run the restaurant. You need supplies like plates, forks, knives, so on and so forth. You need inventory of goods, inventory of food that you can cook into finished meals. So those are the things that you will need. And to acquire all of those, you're going to have to pay for them. So for operating activities, we're going to have, for every activity, we're going to have two categories, an inflow of cash, which is a cash plus and an outflow of cash. So for a restaurant or for any business, the outflow of cash will involve paying suppliers for goods and services. If you need to buy the supplies like plates, utensils, forks, knives, well, you need to pay for those. So that's going to reduce your cash. You need to pay salaries and wages. These individuals that work here that are producing the food, they need to be paid. Well, you need utilities. You need to pay for operating expenses like lights, utilities in general. You need utilities. To operate a restaurant, you need to pay utilities. Also, when you make a profit, you have to pay taxes on that profit. You also have to pay interest on the debt and that's considered operating activity. So any of these activities, it's going to consume cash. It's going to consume cash. Now, that's kind of not the bad news. That's like that. They think we don't like about the business, but at the same time, we're going to have an inflow section. The inflow section usually comes from these people, people that comes to your restaurant and they pay for their food and their drinks. So it's going to come from cash sales to customers, collection on credit sales. So basically those two are related because after you, after you sell the customer on credit, they will pay you. So basically cash from customers receipts of interest revenue. Let's assume you have some money in the bank, that money generated interest. Well, that's interest revenue. Now, bear in mind, I am dealing with US GAB, the United States generally accepted accounting principle, the cash flow statement. Also, if you receive any cash from dividend revenue, if you have some stocks, you're invested in stocks and your stocks pay you some extra cash in dividend, that's also considered operating. But generally speaking, when we think about a business, their main source of revenue is cash from customers and cash collected on account, also cash from customers. So those are the big, two big pluses. The other one are like small pluses for most businesses. They might have some extra money invested in the banks. They might have some money invested in the stocks and it pays dividend or they generate revenue from the bonds, but that's minor. So what we do is we net those two out. So if net cash flow is 10,000, cash flow is 10,000 and cash outflow is 4,000, that's really good. It means net, we have 6,000 as a net, net, net operating activities. And we're going to learn exactly how do we prepare the suction later on that I want you to think of the operating activities. And by the way, I should have mentioned this earlier, when you think of the operating activities, think of the income statement, because what goes on the income statement? It's when you operate the business. Think of cash inflow as, in quote, revenue, but it's all in cash. Think of cash outflow as expenses, in quote, but all in cash, converting all your revenues in cash, converting all your expenses in cash. And finding out on a cash basis, do you have more revenue cash than expense cash? And obviously you want to have more revenues than expenses in cash. Now, when you think about investing activities, here's what you want you to think of. I want you to think of two things, the physical structure of the building, property, plant and equipment. So this is Olive Garden, an Italian restaurant. The building that they operate in is property, plant and equipment. And for the restaurant to buy this building, they have to, to buy the building, they have to spend cash. So this is the minus to buy this building, they have to pay cash. Usually that's the largest component of a typical company. But also Olive Garden, they can buy long term investments, they can buy stocks and bonds and listen to me carefully of other companies. So Olive Garden, they can buy Apple stocks, Microsoft, Amazon, Google, Netflix, they can make investments. They can buy those investments as long term or short term. It doesn't matter. So when they buy stocks, when they buy stocks, they have to pay cash, so it's an outflow of cash. Okay. Also, they can loan money for notes receivable. Simply put, they give you money, you have to pay them back the money plus interest. So they are making an investment. That's why it's called the investing activities. And they can buy also intangible asset. Intangible asset, think of them very similar to buy tangible asset like plant assets. Okay. So those are the outflow section of the investing activities. Now, just like we have outflow, we have also an inflow. And the inflows are the exact opposite of the outflow. What are the inflows of cash? Well, now we bought the building, we could also do what? We can turn around and sell this building. When we sell this building, when we sell this building, we no longer operating, it's going to bring cash to the Olive Garden. Well, just like we bought the stocks, now we can sell them. We can sell those these investments. We can sell our short-term investments. We can sell our long-term investments. So notice they're the opposite of the outflow. They're the opposite of the outflow. We can sell them. Also, we can collect our note. Remember, we lend money. It was a cash outflow. Then when we collect the money, it's a cash inflow. Also, any intangible, we can sell it. And also, we can sell the note. If we have any promise, somebody promised to pay us and we can't wait. We can sell this promise to someone else and get our money now. This process is called discounting. That's also part of investing activities. So simply put, what are we looking at when we deal with investing activities? Simply put, we are looking at two categories, two main categories. One and two. And we'll see those later on when we look at this section specifically. But I just want to plant the seed. Look at your property, plant, and equipment. PPNE. And look at your investments. Investments and stocks and bonds. Investments in other companies. Stocks and bonds. And when you invest in bonds, simply put, you are lending money. So this is what you are looking at. Either property, plant, and equipment, or investments and stocks and bonds. Those are the two main categories that you deal with when you are dealing with investments. If you acquire property, plant, and equipment, it's a negative cash. When you sell them, it's positive. Same thing with investments. When you acquire investments, it's negative cash. When you sell these investments, it's positive cash. The third and last category, the last category in the cash flow statement, according to US GAAP, is the financing activity. And the word financing is how do you finance your business? Well, how do you finance your business? Think about it. How do we finance our business? We finance our business by issuing stocks and bonds. And when we say bonds, bonds the same thing as borrowing. Bonds is a form of borrowing. So this is how we raise money. So under financing activities, we're going to bring cash from issuing our own stocks, whether it's common or preferred. That's going to bring us cash, cash inflow. We're going to issue short-term debt or we can issue long-term debt. It doesn't matter. When we issue that, it means we're borrowing money. Also, the owner could contribute money, very similar to issuing stocks to the owner. Or we can reissue our own treasury stocks. So if we have any treasury stocks, stocks that we purchased in the past, if we resell it, it's going to bring us cash. Those are the inflow of cash. Well, what are the outflow of cash? They're the exact opposite. They're the exact opposite. Well, notice, we said we can issue stocks, but also we can buy it back. So after we issue the stock, we can repurchase the stock. When we repurchase the stock, it's an outflow of cash. Cash would leave the company. Just like the owner contributed the money, the owner's can withdraw the money. That's an outflow of cash. Just like we issued short-term debt, we borrowed money, now we pay off short-term and long-term debt. They're exactly the opposite. And when we issue stocks, we have to pay dividend. Dividend is an outflow of cash. Basically, they're opposite of each other. And that's why it's very important to understand that raising money, it's an inflow of cash. And how do you raise money? When you issue, when you issue, when you sell your own stocks and your own bonds. And I emphasize own the company, own stocks and own bonds, because if it's other companies, look, other companies goes under investing activities. It goes here. But when you're dealing with your own stocks and your own bonds, you are investing, you are financing your own company. Then at some point, you're going to pay back the investors, you're going to pay back the creditor, and that's outflow of cash. One last thing about the statement of cash flow is some activities on the statement of cash flow is considered non-cash investing and financing. What do we mean by non-cash? Non-cash means something happened. It either changed our investing or financing or both at the same time. But it did not involve cash. That's why it's called non-cash. Like what? Well, retirement of that by issuing stocks. Well, let's assume you have a debt. You have a loan of, you have a bond and it's a million dollar bond. You don't have the money to pay the bond holder. You would say you would tell the bond holder, give me the bond. I'm going to debit bonds, payable, a million, and I'm going to give you instead common stock that's worth a million. What did I do here? I retired my bond by issuing stocks. No cash is involved. Is this a financing or is this an investing? Well, this is basically a financing, but it's a non-cash financing. Also, you convert your preferred stock into a common stock. You have preferred stock. You took them back and you issue common stock. It's investing activity, but non-cash. Lease of assets in a capital lease transaction. You leased a building. You leased a vehicle. Well, guess what? You have the asset. You did not pay any cash. Today you did not pay any cash. Now you have the asset and you have the liability, but no cash was involved. You purchased a long-term asset by issuing a note or a bond. Like you bought a piece of land. You debit land for a million. You credit notes payable for a million. Well, you bought the land, okay? Land which is an investing app. Land which is an investing activity. Land is an investing activity. INV and notes payable is a financing activity. So notice one is an investing, one is financing, but neither did not involve any cash. Or the exchange of non-cash asset with another non-cash asset. You exchange an old truck or two old trucks or three old trucks with a new truck. You'll exchange them. You have a new asset, but you did not really pay any cash. Basically, it's an investing activity, but it's a non-cash. Or you purchase non-cash asset by issuing equity or debt. So you bought some vehicle, a building, but you did not pay cash. You issued equity. You issued stocks or you issued debt. What do we do with those activities? Those non-cash activity? We disclose them. We disclose them because if we don't disclose them, if somebody looking at the cash flow statement and we did not tell them about the non-investing and financing activities, they're going to be confused. Because the cash flow statement, if someone knows how to read the cash flow statements, it should make any sense. So if anything is missing from it, you'll be able to notice fairly quickly that something is missing. If you have any questions, any comments, by all means, let me know. In the next recording, I would look at the operating section. As always, I would like to remind you to like the recording, visit my website, subscribe, stay safe, study hard. You're going to study for your CPA once in your lifetime. Don't take any shortcuts. Check out my website. I'm here to help you succeed and stay safe.