 Hello, and welcome to this session. This is Professor Farhad, and this session would look at an overview of the statement of cash flow. This topic is typically covered in intermediate accounting. The CPA exam, the far section, very, very heavily. If you have not connected with me on LinkedIn, please do so. YouTube is where you would need to subscribe. I have 1,500 plus, not only intermediate accounting. I have covered 10 to 12 other accounting courses, including CPA, questions, and material. On my website, you can have access to additional information, such as the PowerPoint slides you are seeing, multiple choice, true, false, note. And if you are studying for your CPA exam, 2,000 plus CPA questions, as well as our exercises that are considered quasi-CPA simulation. So what is the purpose of the statement of cash flow? There's the primary purpose is to provide, obviously, information about the company's cash receipts and cash payment. Cash coming in and cash leaving a company during a period of time. Period of time means for a year, for a month, for a three month, for semi-annual. Just like the income statement, the cash flow statement is for a period of time. That's the primary purpose. The secondary purpose of the financial, of the cash flow statement, is to provide cash basis information about the company's operating, investing, and financing. We're gonna define operating, investing, and financing shortly. Let's talk about the cash basis. Well, what is cash basis? Cash basis in contrast to accrual basis. When you prepare your financial statements according to GAAP, you prepare your financial statements using accrual. Well, guess what? Sometime you wanna see on a cash basis how well you are doing. Because cash is game, cash what matters. When we evaluate the company, we evaluate the company based on their future cash flow, not based on their future net income. So to understand the cash flow, you have to understand how to convert the financial statement from accrual to cash basis. And this is basically what we are doing. And when we do so, we're gonna break down this process by three sections. One is operating, two is investing, and three is financing, which we're gonna be talking about shortly about those three topics. So don't worry about those three concepts. I'm gonna define them in detail shortly. So what is the usefulness of the financial statement? So why is the financial statement useful? I just told you already to basically, if you are computing the net present value, if you remember how to do the net present value, you'll take your future cash flow, cash flow one plus cash flow two, and you discount to the present value. So you need that cash flow, you need the CF. That's one thing. Well, it's the entity's ability to generate future cash flow. And this is what matters for investors, for creditors. What matters is, are you bringing cash? I don't care if you are making sales. It's easy to make sales. You can lower your prices, you can make sales, or you can lessen your credit standard. Basically, you would sell for anyone and you would sell them on credit and you can generate sales. That's not what matters. Can you convert the sales? Can you convert the account receivable into cash flow? And that's what matters. And this tells us, can you pay us dividend? As shareholders, do you have the ability to pay dividend? Can you meet your obligations? Specifically, what are your obligations? Your debt to the banks, your debt to your lenders, your debt to your suppliers, your debt to your vendors. Also, it gives us the difference between net income, which is a cruel net income and cash flow from operating activity, which is net income on a cash basis. So basically it gives you net income on a cash basis as a term that I just kind of, I use as it's not official, but think of it, you're going from net income on a cruel basis to net income on a cash basis. Also, on the cash flow statement, they're gonna show you cash and non-cash investing and financing transaction. You might be saying, what are those cash and non-cash? Well, cash, you already know that those are cash transaction. There are certain transactions that they don't involve cash. I'll give you an example for now. We're gonna look at them in a later session. For example, if you exchange land for a building, if you exchange stocks for a building, if you exchange bonds for stocks, if you exchange bonds for stocks, those are non-cash investing and financing. Don't worry, we're gonna talk about them very shortly. Okay, now let's take a look at the classification of the cash flow statement. And this is important. This is what we're gonna be discussing, operating, investing and financing. So the three components of the cash flow statements are, one is operating activities, two, investing activities, three, financing activities. So those are the three components. Now we need to understand the big picture for every component. What does the operating activity deals with? Usually the operating activities, not usually, it covers the income statement items. What goes on the income statement? It's revenues minus expenses equal to hopefully net income. So what happened is this, the operating section of the cash flow statement, take a look at the income statement and convert the income statement into a cash income statement. It converted it into a cash income statement. Well, what does that mean? It means you're gonna look at revenues. And remember, some of the revenues are cash, and some of the revenues are on account. So notice, we don't only deal with income statement, we have to deal with balance sheet account. Account receivable is a current asset. Expenses, some of our expenses are cash, and some expenses are on account. Again, it's not only the income statement, it's also liabilities on the balance sheet. So simply put, when you're looking at the income statement, you're gonna be, you're going to be looking at two things. You're gonna be looking at the income statement and would look at this, don't worry later on. Income statement items plus, we're gonna look at current assets and current liabilities. Write this down for now. Just, so the operating activity deals with the income statement and deals with current assets and CL current liabilities, okay? That's the operating activities. We're gonna look at a picture of it shortly and we're gonna prepare one shortly, but this is the big picture. Investing activities. For me to explain for you investing and financing activities, let's build a quick balance sheet. So what does a balance sheet looks like? Balance sheet will have assets on one sides, will have liabilities in stock holders equity on the other side. And those two sides should equal to each other. Obviously it's a balance sheet. Under assets, we have current assets. And I just told you current assets are covered. Let me just change this color here. I already told you current assets deals with operating activities. Current assets are operating activities. What else do we have? We have non-current assets or long-term current assets. Long-term, let's call it long-term. We have long-term assets. We have current assets and we have long-term assets. When it comes to, well, under long-term assets, we have property, plant and equipment and we might have investments like when we invest in other companies. Now we could also have intangibles. We could have a section for intangible asset. But what I want you to focus on now is the investing activities. When it comes to the investing activities, what we're doing is we're looking at those two items. We are looking at the changes in property, plant and equipment and we're looking at the changes in investments. So investment activities is the changes in investments and the changes in long-term assets and specifically in investments. Specifically investments and long-term assets. What are investments? Investments could be stocks, could be bonds of in other companies, okay? And long-term assets are mainly property, plant and equipment and land, obviously land. This is what investing activities looks. This is what we focus on when we're analyzing investing activities. The third section is financing activities. And what is financing activities? Is financing activities is how we finance ourselves. Now, how do we finance ourselves? How do we finance ourselves? Well, we finance ourselves either through that or through equity. Therefore, the financing activities specifically, it's gonna look at long-term debt. Remember, current liabilities are already taken. So let me just kind of put down current liabilities here. Remember, current liabilities, I already told you, current liabilities are part of the operating activities. Okay? So long-term debt is the debt that we borrow on a long-term basis. And this is financing activity, how we finance ourselves. Then it's common stock. How we finance ourselves, we issue common stock. And sometimes we buy back common stock. So financing activities deals with our debt and our specifically equity common stock. Now, sometimes we buy, sometimes we sell. We also pay dividend. Well, dividend don't go under the equity section, but also it deals with dividend because dividend is how we finance ourselves when we pay dividend to the shareholder it's part to compensate them. So when it comes to financing activities, we are looking at long-term debt and stockholders' equity accounts, which could be preferred stock, common stock, treasury stock, paid in capital, so on and so forth. And notice, practically, we covered everything on the balance sheet. Current assets and current liabilities we analyze them for operating activities. Long-term assets are under investing. Long-term debt plus equity are financing. Now, this is the big picture, but I want you to be taken notes because once we look at some numbers, we have to know where the numbers are coming from. And often the questions is, they will give you a transaction and they want you to know under which section does it go? Well, if you understand the balance sheet picture, then it's easier for you to understand. So let's take a look at another picture of what we just said, operating cash flow. We have cash flow coming in, we have cash flow leaving. Where does the cash flow come in from? Usually comes from sales. It also comes from if you lend money or if you invest in other companies and receive dividend. Notice here, dividend received, not dividend paid. Dividend received. This is the operating cash flow in specifically inflow of cash. Where do you spend your money when you operate your business? You pay your suppliers for inventory, you pay your employees for services, you pay taxes for the government and you pay your lenders as well as other expenses. So those are typical items that goes on the operating section of the cash flow. Investing, remember what did I tell you about investing? Investing deals with two things. It's either your property, plant and equipment or your investments. So for investing, you could be bringing cash, inflow of cash from the sale of property, plant and equipment. And you could be having cash outflow when you purchase property, plant and equipment. So those are the positives and those are the negatives. Cash coming in, cash going out. You could also sell debt or equity, which is bonds and stocks of other companies when you invest in other companies or you can buy them. You can buy bonds and stocks from other companies. When you sell them, it's a positive. It's bringing cash in when you buy them. It's negative. You can collect principles on loans to other entities. If you lend money out when you collect the money, that's a cash inflow. When you make the loan, it's a cash outflow. So those are, again, as we said, it's long-term asset items. If you are buying them, if you are bringing them in, you have to pay cash. When you sell them, you bring cash in. The financing deals with long-term debt and equity items. Under financing, you have a cash inflow. What's gonna bring you cash inflow when you sell your own stocks, when you sell your own stocks, when you issue your own bond or when you issue your own note, when you borrow money? And what's gonna be cash outflow when you pay shareholders dividend? You remember, you get money from them. Now you have to pay them dividend. Then it's gonna be a cash outflow. So this is the plus and this is the minus. And when you redeem long-term debt and re-acquire capital stock, redeem means you are paying off your liabilities. Then you have to pay money or when you re-acquire capital stock, it's called treasury stock, then you are, then you have to pay money to acquire your treasury stock. So those are the three components. Don't worry, we're gonna work with numbers and exercises, but this is again, the big picture. You wanna make sure you know what cash equivalent is because when we're preparing the cash flow statement, we wanna see what is cash equivalent. The basis recommended by the FASV for the statement of cash flow is actually cash and cash equivalent. Now they keep saying cash equivalent that's gonna go away, but it hasn't been, didn't go away. So what is cash? Cash, we know what cash is. What is cash equivalent? That's a definition you may wanna know. Are short-term, highly liquid investments that are both. So they have to have those two conditions plus the third condition. They are readily convertible to a known amount of cash and so near their maturity. So they present insignificant risk of changes in interest rate. Well, what does that mean? Let's explain this in simple English, but that's something you have to know. It's a definition. Short-term means it's something that you're gonna convert very shortly into cash and highly liquid means it can be easily converted into cash. So it's readily convertible to a known amount of cash. An example will be Treasury Bill. When you lend money to the government, you buy T-Build. In those T-Build, they have to be, for it to be considered the cash equivalent, it has to have a maturity of three month or less. So you lend the government for three month or less. Guess what, at any point in time, you can convert that T-Build back into cash and it's so near their maturity, so it's less than three month. Therefore, changes in interest rate will not affect it that much. That's what's considered cash equivalent. But let me show you this picture. I'm just gonna give you an idea, kind of expand your horizon about the cash flow statement. This is a phase of the company, introductory phase, growth phase, maturity and decline. And this is cash negative and cash positive. When the company start to operate, so let's take a look at those three lines separately starting with operating. When the company start to operate, they may have negative cash flow. It means they are not making a lot of money from operating the business in the introductory phase. Notice in the introductory phase, they are negative. As they grow at some point, as they grow, they become cash positive. And as they read maturity, they max their cash, then as the company decline, their cash flow will go down. This is from operating. So operating activities early on in the life of the company, cash is negative. Same thing with finding investing. Investing means you are buying property, plant and equipment. You are buying investments, usually property, plant and equipment initially. So when you are buying property, plant and equipment during the introductory phase, your cash is negative because you keep on buying and buying and buying. At some point, you're gonna reach maturity. Once you reach maturity, okay, your cash, you may not need to be buying more or you may need to buy a little bit more. Until you reach the top of your maturity, then you'll start to downsize, you'll start to sell property, plant and equipment, then cash will go back to negative, okay? However, financing, when the company start, they borrow a lot of money from bonds and stocks. Therefore, they will start with positive. As the company mature, as they grow and they mature, now they finance themselves from their own operation. Notice, then they will start to buy, pay back the investors and the creditors. Hopefully, it just kind of tells you what phase in life cash flow is affected, how cash flow is affected. And those are general rules, those are not written in stone, okay? So format of the statement of cash flow, what does the format looks like? Well, the presentation, first, the first section of the cash flow is the operating activities, that's the first section. Again, we're gonna work with those, just you need to know it's the first section. And operating activities can be prepared using two methods. We have two methods. We could either use the direct method or the indirect method and we're gonna work with both. Then the second section is the investing activities. There's only one method for the investing activities. It's one method, that's it, there's no name for it. And the financing activities, only one method. So we have three sections operating and then under operating, you could either use the direct method or the indirect method. And investing and financing, it's the same. And also the company, what they would do, they would report inflow and outflow from investing and financing activities separately, okay? So what we will do if you have any non-cash transaction, we will show those separately, okay? Now let's take a look at a skeleton of a cash flow statement. What does it look like with those three component? This is what the cash flow statement would look like. The first section is the cash flow from operating activities, cash flow from operating activities. And this is the first section. Once we prepare the first section, we're gonna have a net cash flow either provided, it means positive or negative used by operating activities. And it's very important to notice the terminology because on the CPA exam, what's gonna happen? If you work in assimilation, if the cash is positive, you have to use the word provided. If the cash is negative, you have to select the word used. So make sure you're aware of this. The second section is cash flow from investing activities. We list all the inflow and the outflow. Then we're gonna have a net cash either provided or used, okay? So here we're gonna, let's go back to the operating. So cash flow from operating, we're gonna have adjustments, we're either gonna have positive or negative. Let's assume this is positive. So we end up positive $1,000. The second section is cash flow from investing activities. We're gonna list all the inflows and the outflows then we're gonna net them. And when they net, let's assume they net negative 300. Okay, so we bought, you know, overall we bought more in the company that's the net, it's net used. Then we have the third section, cash flow provided from financing activities. We're gonna list all the individual inflows and outflow. Then we're gonna have the net and the net will either be positive or negative. Let's make it negative, negative 100. Okay, then we're gonna have, we're gonna net all those three. Net, the increase or the decrease. So 1,000 plus minus 300 is 700 minus 100 is 600. So the net is an increase of 600 cash. Then we'll take the increase, then we'll add it to our beginning cash. Let's assume beginning cash, we had $200. Then we come up with our ending cash. So basically we started with $200 the year. We started with $200, started the year with $200. We end up with 800. Why? Because cash went up by $600 and we show that 1,000 came from operating. We spent 300 on investing and we spent 300 on financing. Again, this is a brief, brief overview of a cash flow statement. We're gonna learn how to prepare this cash flow statement in details starting the next session. Now before we proceed to the next session, I wanna make sure you understand you need to work some multiple choice questions, some multiple choice questions that reinforce what we just learned. I don't want you to move on unless you understand the big picture. And this was the big picture. In the next session, we would look at practice about the same topic overview of the statement of cash flows. It's very important that you have a good understanding of this topic before you move on to the various section of the statement of cash flow that we looked at in this session. Anyhow, I strongly suggest you visit my website for additional resources and I strongly suggest considered subscribing to my website. It's an investment in your career. Study hard, especially if you're studying for your CPA exam. Good luck.