 Oh, and welcome to this session. This is Professor Farhad and this session we're gonna be looking at the statement of cash flows. In the prior session, we looked at the balance sheet and in the prior chapter, we looked at the income statement. It's very important that you have a good understanding of the balance sheet, good understanding of the income statement before you dive into the statement of cash flows because the statement of cash flows derives its information from those two financial statements primarily. This topic is covered in intermediate accounting and heavily covered on the CPA exam far section. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1500 plus accounting, auditing, finance and tax lectures. This is a list of all the courses that I cover including CPA questions. On my website, I do have additional information such as PowerPoint slides, notes, multiple choice, true false quasi CPA simulations and 2000 plus CPA questions. So the income statement, the statements of stockholders' equity and the balance sheet each presents some information about cash of an enterprise during a period. So if we look at the income statement as well as the statement of stockholders' equity as well as the balance sheet, they do provide some information about the cash flow of an enterprise. So we need a complete picture about the cash flow. And in chapter, later on, I believe in chapter 23, we're gonna look at a more detailed cash flow statement. But it doesn't matter. Once you learn the basics in this session, you'll be good to go. In other words, if you learn the steps, it doesn't matter how many accounts do we have, you'll be good to go. So the statement of cash flow presents a detailed summary. So it's gonna show you a summary of all cash inflow, of all cash inflow and outflow in a business. So we're gonna be looking at the inflow of cash and the outflow of cash. Or in other words, the sources and the uses of cash. Simply put, we're going to determine where that cash came from and where that cash go. The inflow we call them the sources, the outflow we call them the uses of cash during a period. The statement of cash flow helps assess a very important concept that we need as users of financial statement. The statements of financial statements meets the objective of financial reporting. If you remember from chapter one, the objective of financial reporting is to help you analyze the company's cash flow. So the cash flow statements help you assess the amount, timing and uncertainty of future cash, which is the risk of future cash. So that's why it's an extremely important financial statement. And eventually we would look at one whole chapter that deals with the cash flow statement. So what is the purpose of the cash flow statements is to provide relevant information about the cash receipts, which are called also inflow or sources. And cash payment, which are called outflow or uses of an enterprise during a period. The statement provide answers to the following questions. Where the cash came from? Where the cash came from? Where was cash used? So what is the source of cash? Again, we're repeating the same information. And what are the uses of cash? And what was the change in the cash balance? If we're looking at the cash balance, what was the beginning balance and what was the ending balance? And we're gonna try to explain that change. If you study accounting further, one of the companies that they use as to illustrate the importance of cash flow statements is WT Grant. And WT Grant was a retailer. And WT Grant, basically before Macy's, before the retailers that we have today, what they did is for a number of years, okay, if actually if you graph their performance over a seven-year period, what you would show is this. Their net income was good. Notice here, the net income was good. The graph for net income, their cash flow, their cash flow from operation, it was going down. So notice, but no one paid attention to the cash flow statement. Actually, it wasn't required back then. I believe it wasn't required, but if it was, nobody paid attention because even if it's not required, you can prepare a cash flow statement. So notice net income and notice cash flow from operation. And we're gonna see what that means. What we are trying to say is net income is not often, it's not enough as an indicator to see how well a company is doing. We need to look at their cash flow and we'll explain this later. But this is WT Grant is the company that's quoted most of the time that shows the difference between net income and the cash flow. Because it's important to generate cash, not net income. Net income is good, but not cash, okay? So the grant experience is a classic case illustrating the importance of cash flow as an early warning signal of financial problem. A more recent retailer, Target, has shown a good profit, but some are concerned a bit too much of its sales has been made on credit rather than cash. So Target might be experiencing the same, but this is again from 2008, Target is in good shape. But once you see that net income is increasing, but cash flow from operating, it's either flat or going down, that's an early signal that the company is not generating enough cash. And the problem with Target is they are selling a lot on credit and they cannot collect. So they're experiencing a lot of bad loans, okay? So you are selling and when you sell, you book your income, but when you want to collect your cash, you can't collect your cash. So the cash flow statement is an early signal for such a problem. So let's first identify the three component of the cash flow statement, the three component. One is operating, one is investing, and one is financing. And we will look at each section, explain what goes into each section, that we're gonna prepare a basic. We're gonna prepare a really basic, but don't underestimate, if you learn the basic, because the steps are the same if it's basic or not basic, it doesn't matter. The steps are the same in how you prepare a cash flow statement. So basically, this is the skeleton of a cash flow statement. You have operating section, it's either you could be bringing cash or consuming cash. You'd have an investing section, you could be bringing cash or consuming cash from this section, and you have a financing section, it could be bringing cash or consuming cash. So let's assume $10 from operating, negative six from investing, and plus two from financing. So 10 minus six is four, plus two is six. So the increase is six in cash. Then you take a look at your beginning cash, let's assume your beginning cash was one, your ending cash should be seven. So this is the skeleton of a cash flow statement. And we're gonna prepare a complete one. So what goes under operating, investing, and financing? So when we say operating, what are we looking at from a cash flow perspective? What are we measuring? The operating section of the cash flow statement, it shows the cash effect of the transaction that enters into determination of net income. So basically really, if you want to look at it, the operating section is taking net income, which uses accrual accounting, and converting it into cash net income. And what do we call cash net income? We call it cash from operating activities, cash from operating activities, from operating activities. Now, why do we do this? We do this because, well, net income is important. Net income is important. But net income, remember, it uses which method of accounting? It uses the, if you really think about it, it uses the accrual method. It uses the accrual method. And that's good. And this is what's gonna give us net income. But what really matters is, can we convert net income into cash net income? Let's call it cash in quote net income. So cash net income is, could you tell me from operation, did you generate cash? Was you have inflow of cash? Overall, or uses of cash? So when you operate with your business overall, did you bring in more cash than what you spent? And this is what the operating section shows. How well did we do when it comes from operating the business? And it's important that we have a positive. It's important that we have a positive, because that's the most important thing in the business. Are we operating at a profit? Not sorry, not a profit. Are we operating and generating cash when we operate? So this is the operating section. The investing section deals with making and collecting loans. It's when you lend money, then you collect your money. So basically you invest. Why? Because when you lend money, you charge interest. You charge interest. So you basically make an investment. Or when you acquire or dispose investments, another thing that we do in investments. So either you buy investment, you buy, you buy investments or you sell investments. If you buy investments, it's a cash outflow. If you sell your investments that you purchasely bought, it's a positive cash flow. And the third item that goes under this section is buying property, plant, and equipment. P and E, you either buy them or you sell them. If you buy them, it's negative. If you sell them, it's positive. If you sell property, plant, and equipment that you previously acquired. So basically three different things goes into the investing section. When you lend money, but when you lend, not borrow when you lend, let me clarify here. Not borrow, because it's two different things, okay? Borrowing means you are asking for money. Lending means you are giving out money in form of investment. When you lend money and when you collect, when you lend money, it's a negative. And when you collect the money, it's positive. And obviously you're gonna collect the interest. Now the interest that you collect, it's gonna be part of your operating. Okay, so the interest is part of operating. So the other thing is we said investments. You either buy investments or sell investments. And the third component that we usually see under investments is property, plant, and equipment. You might be buying property, plant, and equipment, or you might be selling property, plant, and equipment. So this is the second section of the cash flow statement. So this is one, this is one, this is two. The third section of the cash flow statement is the financing section. The financing section deals with obtaining resources from owners by providing them in the return on their investments. What are we talking about? We are talking about common stock. This is how you obtain resources from owners. And borrowing money from creditors. Borrowing money from creditors means what? It means that. So basically, mainly, the financing section deals with common stock and debt, as well as other things. So sometime you sell common stock, that's a positive. Sometime you buy back common stock, it's a negative. And when you buy back your common stock, it's called treasury stock. And debt, sometime you borrow money, when you borrow, it's a positive. And when you pay back, it's a negative, okay? So this is what the financing, how are you financing yourself? There's two ways you can finance yourself. Either stocks or borrowing, which is stocks or debt. Debt or equity, stocks or bonds, okay? Or borrowing, lending, borrowing, notes payable, okay? And this is another section, another picture of it. So operating cash flow, this is the operating cash flow. Again, you could be bringing money and you could be consuming money. So where do you bring money from cash flow? Cash receipts from revenues, okay? And that's gonna bring you cash inflow. And where do you spend the money? When cash expenditure exceeds cash receipts of revenue, okay? So you're gonna have inflow of cash and you're gonna have basically an outflow of cash. Investing, as I said, it's property, plant and equipment. This is basically a review, what we just said, another picture. Property, plant and equipment is one. Sale of debt or equity securities, which is investments to and collection of loans three. If you are selling those, you're gonna have a positive cash. If you are purchasing those, purchasing, purchasing, and lending money, it's a negative, okay? So this is a inflow positive and this is negative. And financing activities, as I said, you're gonna be issuing equity securities, which is common stock. And you're gonna be issuing debts like bonds and notes. Basically what I just said earlier, but this is another picture of it. This is how you bring cash from financing and how do you consume cash from financing? You pay back, you pay dividend to the common stockholders. You redeem the debt. Basically you pay back the debt and you re-acquire your capital stock. Basically the opposite of this. This is when the cash is outflow. And this is what goes under each section of the cash flow statement, okay? So those are the basic components. Let's prepare a basic and we emphasize the basic. Although it doesn't matter if it's basic or not, I'm gonna give you all the steps that's needed, but we're gonna call it basic. So an overview of presentation of the statement. So really to prepare a cash flow statement, you need three things. You need comparative balance sheet, which is year one and year two. So it's a prior year and a current year. So to prepare a cash flow, you need two years of balance sheet. You need the current income statement, current income statement. And you need selected transaction data. And basically selected transaction data means more information about transaction. Because sometime the balance sheet and the income statement doesn't tell you the whole story. Maybe you have, maybe you bought a building, okay? But how did you buy this building? Did you pay cash? That's one way. Did you pay cash and obtained a loan? Did you issue stocks to buy this building? Did you exchange this building for another building? So those are the additional information that we might need. What transpired? Sometime the balance sheet and the income statement doesn't give us the full picture. And the best way to do this is to basically prepare a basic, basic cash flow statement, a basic cash flow statement. On January 1st, 2014, it's first year of operation. Telemarketing issued 50,000 shares of $1 power value common stock for $50,000 cash. So first they issued, the company started and when they started, how do you start the company issue stocks? So the company issued stocks. So that's kind of, although this is not required, but let's talk about this. What type of cash activity is this? Well, if you issue stocks, remember this is a financing activity and this is an inflow of cash. So basically you brought $50,000 under financing. The company rented its office space, furniture and telecommunication equipment and for marketing services throughout the year. So that's, they rented their equipment and they started to operate. In June, the company purchased land for 15,000. Well, how did they, for 15,000? I'm gonna assume they paid cash. When we buy a land, what type of activity is this? Well, hopefully we know. When you buy property, plant, and equipment, this is an investing activity and basically you paid out cash because you purchased the cash, okay? Illustration 15-9 shows the company's comparative balance sheet at the beginning and at the end of 2014. So this is the balance sheet that we are giving. This is the balance sheet that we are giving about this company, okay? So notice this company does not have a prior year. It doesn't mean anything. If it has a prior year or not, it doesn't matter because we assume the prior year, if it doesn't exist, not we assume they were zero. So you remember we need two years of financial data. This is the prior year and this is the current year. There was no prior year. Therefore, notice the prior year are zero. There are figures, it doesn't matter. If there are figures or not, it doesn't matter but we need two years of data to prepare the cash flow statement. So the first thing you do is you find the difference between the accounts, okay? You find the difference and you're gonna see why this is important for later. And the first one is cash. And all what we know is cash increased by 31,000. So cash increased by 31,000 and we need to know why, so the whole purpose of the cash flow statement is to explain this increase. We cash increase by 31,000. So obviously it cannot decrease because it was zero from the prior year. So it increased by 31,000. So the first one of the steps that you have to undertake is to find the differences between your accounts. For example, account receivable went from zero to 41,000. That's a 41,000 increase. Land went from zero to 15,000. Accounts payable went from zero to 12,000. Common stocks went from zero to 50. Retained earning went from zero to 25. And what we did is we showed the increases. Just on the side, we wrote down the increases. Why is this important? This is important for later. For later means very shortly. So this is the comparative balance sheet. Now we're gonna look at the income statement. On the income statement, they generated revenues of 172,000. They incurred operating expenses of 120, income before taxes is 52, income tax is 13, and this is net income. Dividend for the year were 14,000. They paid for the year. So they're also giving us how much dividend we paid for this company. So the first thing you do is you prepare, the first thing is you determine the net cash provided or used from operating activities. And remember operating activities is what? It's basically taking net income, which is a cruel and convert it into cash net income. So we need to make some adjustments to convert that number into a cash net income. This is the purpose of operating. Then we need to determine the cash provided or used from investing activities and financing activities. Then determine the change in increase or decrease in cash. We already know cash went up. We have the answer for this of 31,000. Then reconcile the change with the beginning balance, happens to be zero. So 31 plus zero, it's gonna give us 31,000. But the point is to determine how did we come up with this 31,000? It has to do with operating, operating, investing, and financing. It has to do with operating, investing, and financing. And by preparing the simple cash flow statement, we are going to find out, we are going to find out what actually transpired, what actually transpired. So what I'm gonna do before we start, I'm gonna give you the steps, give you the steps for preparing a cash flow statement, starting with the basically the operating section. So what are the steps and using the indirect method? Because you would see later, we have the indirect method as well as the direct method. Or we're gonna be concerned with is for this chapter is the indirect method. Eventually, once we get to the cash flow statement chapter, you will take this at the end of the course and intermediate accounting toward chapter 2223, you will have the direct method. So basically for the indirect method, I'm gonna give you the steps that, I say step one, you start with net income. And after net income is given to you, if it's not given, you have to figure it out. Step two, analyze current assets. And let's just do both current assets and analyze current liabilities. So this is the same step. We're still talking about the same step. Step three, add non-cash expenses such as depreciation, amortization and bad debt. Step four, deduct losses, I'm sorry, add losses, add losses, deduct gains, if you have any losses or any gains. So those are the steps that we need to undertake. Now we're not gonna go through, maybe you're not gonna use every one of them, but those are the complete steps that you need to do to prepare the cash flows operating section. So here we go. This is, we are starting, we have the competitive balance sheet, we have the income statement. So step one is net income. Okay, net income is given to us 39,000, pretty straightforward. The next thing we're gonna do, we are going to analyze current assets and current liabilities. And this is very basic, very basic example, as basic as it gets. Here's what we are saying. We are saying a count receivable went from zero to 41. What does that mean? It means, if you look at an account receivable, T account, account receivable, T account, it went from zero to 41,000. It means account receivable, net increase is, the net increase was 41,000. It means what? It means throughout the year, it means throughout the year, we sold more on account than we collected. Because remember, throughout the year, what did we do? Every time we made a sale, we debited account receivable, we credited sales. So account receivable went up, sales went up. Then when we collected the cash, we debited cash, credited account receivable. Cash went up, account receivable went down. And we did this, let me just exaggerate, one million times this transaction. Debt account receivable, credit account receivable. Debt account receivable, credit account receivable, one million times. It doesn't matter how many times we did it. Overall, the account receivable increased by 41,000. It means what? It means we sold more on account, sold more on account, than collected in cash. So we sold more on account than we collected in cash. Well, simply put, if account receivable went up, it means this amount here, 171,000, 41,000 of it not collected yet. Well, if I'm taking my net income and converting it into cash, well, if I did not collected yet, if I did not collected yet, it means I need to deduct, I need to deduct that increase in cash. Because if I did not deduct it yet, I'm sorry, if I did not collected yet, it means it's not cash. It means there are 41,000 of accrual net income. And I don't care about accrual net income. I want to know what is my cash net income? Well, my cash net income, I'm sorry, not my accrual sales. I want to know what is my cash sales. Well, my cash sales is not 172. My cash sales is 172 minus 41. And the opposite would have been true if account receivable rather than increase, decrease. It means I collected more than what I have put into the company. So hopefully we can see this, okay? This means I need to deduct 41,000 as a result of the increase in my account receivable. Now the rule is this. Because when we are preparing, let me go back to the Excel sheet. So we did step one, now we're working on step two. The rule is this. And if you want to write it down for later, it's very important that you do. If your current, it's a little smaller here, thinner. Okay, if your current asset, if any of your current asset, if any of your current asset, the change, this is the delta sign, the change is up in this situation, which it was, it means cash flow went down, just like an account receivable went up. If an account receivable, the change is down in any current asset, and specifically, and to be even more broad, any asset, if it goes up, it means cash flow goes down because to acquire more assets, you need cash. If the change in assets or current assets went down, it means your cash flow went up. And this applies to all your assets, including current or non-current, it doesn't really matter. So this is one of the steps that I told you you will need to know. So this is how we analyze current assets. Now in the book, you could read about inventory and other current assets, but again, if your assets goes up from a cash flow perspective, it means you acquired more asset. And if you acquired more asset, how do you acquire more asset? By consuming cash, by, this is how you acquire more assets, you consume cash, okay? So this is the first step. Now if we had more than one account receivable, we could have many account receivable. It doesn't matter how many do we have. The rules are the rules and it will stay the same. So let's go through the first step, net income, then an increase in account receivable gives us a negative 41. Now, so we analyze current assets and current liabilities land, not current assets. So we're done with current assets. Let's look at current liabilities. Remember, under current liabilities, if we have any sorts of a node spayable, that's a financing activity. Just be careful. Any node spayable is a form of financing, not of operating. We're gonna analyze account spayable. Account spayable went from zero to 12,000. Let's analyze account spayable. If we have an account spayable account, it went from zero to 12,000. So it increased by, the net increase was 12,000. This was the net increase. Let's think about it for a moment. What happened is this? Throughout the year, every time we buy on account, let's assume we bought inventory, we debit inventory, we credit accounts spayable. Account spayable goes up, inventory goes up. Then every time we pay down our accounts spayable, we debit accounts spayable, accounts spayable goes down, and we credit cash, cash goes down. So this is the entry. And we had a million of these entries. And what we care about is the difference, the net difference. All we care about is when we net them all out, accounts spayable was up 12,000. It means what? It means we, oops, it means we purchased, more on account than we paid off. So overall, we purchased more on account. If we purchased more on account, it means we used less cash to operate. It means any increase in liability, it means a positive cash flow for me. Therefore, it was an increase. Therefore, it's a positive cash. Let's go to the Excel sheet and put the rules there. If I go back here, when I analyze my current assets, I'm sorry, when I analyze my current liabilities, what do I do? I say, well, if the change is an increase from my cash flow perspective, that's good. It means I'm using other people's money to operate. I'm borrowing money to operate. I'm using other people's credit to operate. If the change in the liability is a decrease, current liability or any liability, it means my cash flow is going down. If you think about it, how do you bring down your liabilities? You have to pay them off. You have to pay them off. And what I showed you here is extremely important. You could have a bunch of current liabilities and current assets. It doesn't matter. The rules always stay the same. And for this cash flow statement, they're only given us a very short, a very small section. So they're only given us one receivable and one payable. And the beginning balance was zero. It doesn't matter what it was. We just have to find the change. You can figure out the difference between two figures. It doesn't matter. And this is it. As far as we're concerned, as we said, this is as basic as it gets. What we did is we looked at net income and converted net income into cash flow net income. And basically this is not very good, not very good. But again, this is the first year. And at least we still have some cash coming from operating. But this is not good. Why? Because notice, if you really think about it, most of the sales that we generated, a lot of the sales is on account. So what happens is we are not collecting our money. This is what this tells us. It means you have a net income, but it seems the company finding hard time collecting their money. Because they did not generate a positive cash flow as much as they should have from operating. But really, this is not a good, we cannot make a judgment because this is year one. And we don't know what business they are in. We don't know what the state of the economy, but this is just an observation from my end. So this is the operating section. So this is how you prepare the operating section. It's right here. And remember the cash flow statement, it's four year ended. It's for a period in time. The second section we're gonna look at is investing section. When you're looking at the investing section, it doesn't matter how big is the balance sheet. You always look at the long term asset, long term assets, or sometimes they are called noncurrent assets. And noncurrent assets would include your investments and would include your PP and E, property, plant and equipment. So you analyze your property, plant and equipment. And for this example, basically we have one property, plant and equipment and that's land. It went from zero to 15. Remember, if an asset goes up, it means cash flow goes down. And what I mean asset is any asset except cash, obviously. So here it seems we consume cash to purchase the land. Therefore, this is the investing section and we only have one activity, we purchase the land, it's negative 15, negative 15. When we're preparing the financing section of the cash flow statement, when we're preparing the cash flow statement, cash flow section, all what we look at is the section that we analyze are liabilities and equities. And we don't have any debt for this company. We have accounts payable, but that's not notes payable, that's not financing. So we only have to analyze those two accounts. But if we have any notes payable, either short term or long term, it doesn't matter. If we had any bonds, okay, those are forms of debt. Here we don't have anything, we only have, we issued stocks. It went from zero to 50,000. So that's an issuance of cash flow, positive 50,000. And the other thing that we are told is we paid dividend of 14,000. We paid dividend, that's another form of financing. That's a negative, because we paid out the dividend. And overall, we had net finance, net cash provided by financing. So we financed the company by obtaining more cash, by money giving from us, from the investors. So this is where the really money came from for this company. Okay, not from the profit, it's from the investors. And what do we do next? After we have all three sections, which is positive 10, negative 15, positive 36, we find the difference between those two. And it should be positive 31. And I told you, we already know it's a positive 31. But all what I know about this company, this company, it's definitely, it's starting up because all what I'm seeing here is they are generating cash, the increase in cash is mainly due to investors, investors contributing money to the company. So this is pretty much a fairly new company, a fairly new company, early on at the stage. And the beginning cash was zero, therefore the ending cash is 31. And hopefully this number reconciled with this number. And if it's reconciled, it's good. It means we prepared the correct cash flow statement. Again, this is very basic. Obviously we're gonna be working a more advanced one either in class, and especially when we get to chapter 23, you're gonna see a much, much more advanced calculation. Now you might be saying, so what are all the other steps for? The one that we, the one that I, the one that I put in here for you, well, we already finished step one and step two. Step three, if you had any non-cash expenses, such as depreciation, amortization, or sometime bad debt expense, those are non-cash expenses. What do we mean by non-cash? It means you debited an expense and you credited something like, if we're dealing with depreciation expense, you credited accumulated depreciation, okay? Or if you debited bad debt expense, you credited allowance for bad debt, okay? It means what? It means you debited an expense, but you did not credit cash. Those are called non-cash expenses. And non-cash expenses, what did they do? They reduced your net income, they reduced your net income, but did not use cash. Why? Because you did not credit cash. Therefore, what we need to do, because we are converting from net income to cash net income, to cash net income, remember cash in quote, cash net income in quote, the whole thing in quote, because we are converting net income to cash net income. So any expense that wasn't really a cash expense, we just basically have to add it back, okay? So this is step one, step two, and step three. Let me erase this, and step four. Step four is add losses and deducted gains. And this is counter-intuitive, hold on a second. Why am I adding losses? Did I make an error? No, I did not make an error. I add the losses, and where do losses came from? Let's think about it. Let's assume you bought a land, I'll give you a simple example, for 15,000, let's not use 15,000. Let's assume you bought a land for 75,000, okay? You bought a land for 75,000, and you paid cash. This is when you bought the land, and you paid cash 75,000. Okay, very good. Now, what did you do? Then you sold the land, and you sold the land for 60,000. You know, you sold the land. Okay, when you sold the land for 60,000, we debit cash, 60,000, let me just make this, bring it down a little bit further, okay? So you debit cash, credit the land 75, and you incurred a loss, a loss of 15,000. So this is the entry when you bought the land, and this is the entry, oops, this is way too much. And this is the entry, and this is the entry when you sold the land. Now, what happened in between is this. When you sold the land, you incurred a loss, and this loss, this loss, this loss here goes on the income statement, and this loss here reduces your net income by 15,000, but there was no reduction in cash. So you reduced your net income by 15,000, but you did not reduce your cash. Therefore, what do we do with any losses when we are making the adjustments? We add the losses, and this is all part of the operating section. And the logic would work the same. Now you might be saying, hold on, so we did receive cash, 60,000, where did this cash goes? This cash goes under the investing section, the investing section, okay? So that's why the loss is taken out, the loss is taken out because it reduces your, I'm sorry, the loss is added back because it reduces your cash without reducing your, it reduces your net income without reducing your cash. And the actual cash that we received, the whole thing will goes under investing. And the gain will be the same. Let's assume we sold this land for 100,000. So if we sold this land for 100,000, we debit cash 100,000. We credit the land 75, and now we have a gain of 25,000. So what happened to this gain? This gain increased our net income. So this gain, the gain, what happened to the gain? It goes on the income statement, and it increased net income by 25,000. But guess how much cash we received? We received 100,000, the whole 100,000, it's gonna go under investing, under the investing. So this $25,000 that increase our operation did not increase our cash operating, cash operating. The whole cash, the whole 100,000 should be reported under investing. Therefore, to prepare the operating section, what do we do with the gains? We deduct the gains. So we add the losses and we deduct the gain. Take a minute and think about what I said, and those are the steps, all the steps to complete the operating section. Again, those are the four steps to complete the operating section of the cash flow statement. So you could reflect on them, maybe work some exercise to see how it really works, but I gave you the full steps. We may see this later on in another chapter, or maybe I will work and exercise some sort of an exercise as an example. But those are the steps. Now let's take a look at the section, report the following item in the most, so what activity is net income? Well, net income, obviously, hopefully we know this is operating. What about dividend paid? Remember, dividend paid is financing. Now, be careful. If it says dividend, if it says dividend receive, then it's operating. So remember, you have dividend paid, okay? And dividend received. When you receive dividend, it means you bought stocks in another company and you receive dividend, it's an operating activity. Anything that deals with current assets and current liabilities, any increase in current assets like account receivable or any changes in current liabilities, those are operating activities, okay? Purchase of equipment, equipment, property, plant and equipment, that's investing. Depreciation expense, that's a non-cash expense and that's operating. Issues of note, anything that deals with notes, what? Notes means loans. Anything that deals with loans, notes, bonds is financing. And remember, you are issuing. It means you are borrowing because if you are, this is where student confused. If you are lending, if you are lending money and that's an investing activity, if you are lending, okay? And here are the answers. So hopefully you know the answers for this, okay? So let's prepare the cash flow for this company. So we know this is operating, operating, operating, operating. So we're gonna start with net income, 40,000. Then we had an increase in account receivable. An increase in account receivable, that's negative to cash. We had an increase in account spay, well that's positive to cash. And depreciation expense, we always add depreciation expense. So this one, so those in green are operating activities. Let's look at the operating activities. And notice we start with net income, increase in accounts receivable, increase in accounts spayable, add depreciation expense, cash provided from operation, which is good. We had net income of 40 and we had cash provided of 75. That's pretty good. Now, the other sections are that we did not complete yet. This is investing, investing, investing, purchase equipment. If we purchase, it means it's a negative, okay? So here under investing activities, we purchase equipment, negative 8,000. And what's left are the financing activities. It seems we have two financing activities. One is we issued a note that's a positive and one we paid dividend that's a negative. Those are the financing activity. So we proceeds from a note that's a plus paying dividend is a negative. So we have the three sections. We have now operating, investing, and financing. We net them out. And when we net them out, we come up with 82,000. So the change in cash was an increase of 82,000. Now what we do, we need to add this to the beginning cash, assuming it was zero, then the ending cash is 82. Assuming it was 1,000, then the ending cash should be 83, okay? All right, let's look at this question. In preparing statement of cash, which of the following transaction would be considered an investing activity? Investing, issuance of bonds at a discount? Well, if you are dealing with bonds, it means you are issuing, issuing means selling. If you are selling your own bonds, that's a financing activity. So that's out. Declaration of cash dividend, if you are declaring cash dividend, that's also financing, because you're gonna be paying dividend. Sale of merchandise on credit, that has to do with your operation. That's operating. And by the process of default, the sale of equipment at book value is an investing section. Now also what happened is, sometime we're gonna have significant non-cash activities. Significant non-cash activities, that means we're gonna have certain activities that do not involve cash. In other words, we have transactions, but those transactions, they affect the company, but they do not involve cash. They are non-cash. They involve other thing than cash. So significant financing and investing activities that affect cash are reported either on a separate schedule or at the bottom of the cash flow statements or in the note. So if you have any of these activities that are considered non-cash, you have to report them separately. What are some examples of those non-cash activities? The issuance of common stock to buy an asset. So what did you do? You bought an asset, but you credited common stock. So you bought a building, so you debit the building, but you credited common stock. You gave the buyer common stock. Let's assume a building for 10,000 or for 10 million. It doesn't matter, okay? You converted bonds into common stock. So you had a bond, but you paid it off. But when you paid it off, we debit the bond and we credited common stock. So notice, no cash is involved. Issuance of debt to purchase an asset. So basically you bought an asset, land. You debit land and how did you buy the land? You credited notes payable. You did not use cash. Those are non-cash activities. Exchange on long-lived asset. Well, you debit an asset, asset one, and you credit asset two. So you gave them one asset, you gave them asset two, and you debit asset one. So you exchange one asset into another asset. So simply put, you debited a truck. You bought a truck, but in return you gave an old truck, an old truck. So you did a trade, okay? Those are all examples of non-cash investing and financing. So dealt with investing and financing the company, but you did not consume cash. So you need to disclose those activities. And this is a complete cash flow statement. So for this company, Nestor company, notice here they start with net income. They added the non-cash expenses. Notice here, they subtract, this is a gain. They subtracted the gain. There was no losses. And where is this information coming from? It's coming from the income statement. There was an increase in account receivable. An increase in account receivable is a negative to cash. A decrease in inventory, inventory is a current asset. When asset goes down, cash goes up. A decrease in accounts payable, if accounts payable goes down, that's a negative. All in all, we had 91,000, 320,000, 750, plus 91,000. We had cash provided. So from an operating perspective, we did good. We had cash provided. Then we had three activities from investing. We sold the plant asset for $90,500. We purchased an equipment for $182,500. And we purchased a land for $70,000. Overall, we spent cash on investing, $162,000. Okay, we spent cash on investing, operating brought in cash. Those are the three activities, the two main activities. And from financing, we paid a dividend, which is a negative cash. We issued stocks, which is a positive. And the redemption of a bond, we paid off the bond, that's negative. That's a positive overall. So we'll take positive, negative, positive. We'll give us overall a positive. We'll take the increase, plus the beginning cash of the year, gives us the ending cash of the year. And also, we purchased the equipment through the issuance of bond. We disclosed this non-cash activity. And I want to see if this example, illustration five dash 23 in your textbook. Just give me one moment, please, as I try to do this real quick. Let me try, if that's the case, I can refer you to it, because this is, it says it's referencing your textbook. So if that's the case, I went through the answer, but I would want you to, I would want you to go over the steps and follow the steps. And you could, if you want, if you want as an illustration, you can see what we did. Let me just go to statement of cash flow and exhibit five dash 23. So this is the one that we were, this is the one that we worked. Now actually also in the book, illustration five dash 23, see if there's anything here. Now that's all they give you a complete one. They don't give you the data how they came up or they just gave you a complete one. Okay, at least it was worth trying. Okay, this is the, so this is a complete cash flow statement. I'm sure we'll work few ones in the homework as well as in class. The last thing is understand the usefulness of the cash flow statements. What use do we have? Do we have of the cash flow statements? First thing you need to know, without cash a company cannot survive. But as you notice, sometimes company can bring cash from financing to survive. And sometimes the worst thing is when companies start to sell their assets, sell to survive. So they will have this section as positive. This is the worst thing for a company. Not the worst, but this is a bad sign, especially if this is negative. If the company is negatively generating, they are using cash for operating the business and they are selling their asset to finance the company and they're selling and they're borrowing money to finance the company. That's a bad sign. That's okay if you have, this section here, it's okay if it's a positive or negative. If it's a new company, this is gonna be a positive because they're gonna be borrowing money. But as the company mature, they're gonna be paying back the loans and rewarding the investors. They understand the usefulness of the statement of cash flow. So for one thing, without cash a company will not survive. So it's extremely important that at least you have a positive cash, okay? Just survive for the next quarter. Otherwise you will close your business. Cash flow from operation. So this is where you really want to have the cash flow. You want the cash coming from what you do for a business. Because here's why. All your problems are solved if you can bring cash from operating the business. Why? Because if you can show investors that you are operating a good business and you are generating cash, no problem at all. You're gonna have investors and creditors lined up to give you money. Why? Because they want to make a profit and here they want to make, they want you to pay interest. So you will have enough people to what we call finance, finance your company. But you have to show that you are generating a positive cash flow from operating the business. So high amount, company able to generate enough cash flow to pay its bills. If it's a high amount and you want to grow, people will be lined up for you to grow. Low amount means a company may have to borrow or issue equities to buy bills. And if you have a low amount, it means you are a risky company. And if you are a risky company and if somebody wants to borrow your money, they're gonna charge you high interest. And if they're gonna buy your stock, they're gonna buy your stock at cheap prices because they're taking a lot of risk investing in your company. So what matters really for a company is how well, how much you are generating cash from operating your business. And one thing we can measure, we can basically look at one of the ratios that we can look at when we are calculating cash. Cash is the current cash debt coverage ratio. So basically we want to know if you are generating enough cash to cover your debt. So how do you do this? You will take net cash provided by operating activities. Let's assume this is $10,000 to keep the number simple divided by the average current liabilities and let's assume this is 2,000, okay? 10,000 divided by 2,000, it's five. What does five mean? Five indicate, this ratio indicate whether the company can pay off its current liabilities from internally generated cash. A ratio one to one is good. This is five to one. It means for every dollar in current liabilities, you have $5 in cash coming from operating the business. One to one will be 10,000 and, oops, 10,000 and 10,000. This will give you a ratio of one. Obviously you want it to be greater than one, greater than, so any number greater than one means good. It means you are bringing enough cash from operating the business. I'm sorry, this is the, sorry. This is current cash coverage ratio. It means you are covering your current liabilities. Another ratio we can calculate is the cash debt coverage ratio. Do you have enough cash coming to cover all your liabilities, to cover all your liabilities? Again, if we take 10,000 and 10,000, just for simplicity, the answer will be one. This ratio indicate a company ability to pay its liabilities from net cash provided by operating activities without having to liquidate the assets employed in its operation. I would say, I would say a ratio one to one, it's not that good because you still have to cover your long-term assets. I mean, I don't have an answer, what's a good ratio, but one to one is, you know, because remember, this cash has to cover current and we are not including long-term, which is the next section, average total, it means including current, current and long-term, current and long-term. So I would say it should be more than one for the current. Okay, this ratio indicate the company ability to pay its liabilities from net cash provided by operating activities. So do you have enough cash coming from operating the business to cover your liabilities without having to liquidate assets, sell assets or borrow more money basically, which will give you into more trouble. So this is another ratio we can calculate from cash. The third measurement of cash is something called free cash flow, free cash flow analysis. This free cash flow analysis tells you if you have a positive free cash flow. How do we calculate the free cash flow? Here's the formula. We'll start by taking operating activities. Did you notice that all the ratios focus on the operating section? Why the operating section? Because if you are not generating positive cash flow from operating, you are really a useless company, okay? Because if you want to survive and if you're a viable business, you're supposed to be generating cash from what you do. And the operating activities tells you if you are generating cash or not generating cash from what you do as a business. So to find out what's your free cash flow, we'll start with your operating cash. Hopefully it's positive, not negative. Then we subtract capital expenditure and those are planned. Planned means how much are you planning to spend on expanding the business? Then we deduct, so it's minus planned expenditure, minus planned expenditure, minus planned expenditure. Then we deduct the dividend. Dividend is you have to pay to investors. Then the investors want to make sure they're gonna be paid dividend, then minus the dividend. And what's left is free cash flow. And any positive number, investors will be very happy because now they have extra cash to do what? To grow the business or to pay them back more dividend. So this is the cash that you want to have a positive. So this amount, the amount of discretionary cash flow a company have that may be used for purchasing additional investments, retiring that purchasing treasury stock or simply adding liquidity to the company. So you can pretty much, when you have cash, you have endless things to do. You can buy more assets, you can pay off that, you can buy back stocks, buy back your own stock or simply adding the company's liquidity. So you have cash and cash is came because cash gives you opportunity. Opportunity when time comes, there's a good opportunity. If you have cash, you can take advantage of the opportunity. So the current cash, that ratio coverage is often used to assess what? Is it financial flexibility, liquidity, profitability or solvency? And when we talk about current, current deals with liquidity. Are we enough liquid in the short term, liquidity? Now, the other ratio that we talked about is the overall debt coverage ratio. Oops, sorry. This is the current, this ratio here, cash debt coverage. This covered all the debt. This deal with how flexible are we? How flexible are we? Because the more coverage we have, the better off we are because we have flexibility. When you don't have that as a company or as an individual for that matter, the less that you have, the more financial flexibility you have. If you have any questions, any comments about this topic, please let me know. In the next session, I'm gonna look at the supplemental disclosure. Once again, I'm gonna invite you to visit my website where you can practice exercises about the topic that you just view. And I strongly suggest you subscribe. It's an investment in your career. Study hard and study hard for your CPA exam.