Welcome. In this video we're going to talk more about cash flow statements.
We're going to focus on how we organized cash into different categories.
The cash flow statement like all accounting financial statements derives a lot of
its benefits from the fact that it takes the individual transactions of the firm,
aggregates them up and puts them into categories of like
transactions in a way that will help us better understand what's going on in the firm.
Let me show you a little more about that.
Think about what the cash flow statement really does.
It explains the change in cash.
So at a simplistic level we can think of that as starting with our ending cash balance,
subtracting from it our beginning cash balance and the difference is the change in cash.
You can do that right off the balance sheet.
Of course if somebody just tells you the change in cash was I don't know, $40,000.
That's not all that useful.
You're going to start saying, "Well,
why did cash change by that much. How did you use it?
What did you do with it?"
Well, in order to do that we're going to create a couple of different categories.
The first category is the operating cash flow.
Then we're going to have investing cash flow.
And finally we're going to have financing cash flow.
Our cash flow statement is going to break our cash change down into
these three categories so that we can
understand when a similar source or use of cash has occurred.
Let me give you the details of what goes into each of these categories.
We'll start at the top with operating cash flows.
This is straight out of the accounting standards in the U.S.
The first thing I want you to notice is they actually start by saying,
"operating activities include all transaction and
other events that are not defined as investing or financing activities.".
Basically, they're saying if your firm does it and it doesn't seem like it's
an investing or financing activity it must be
something you've done to operate. I get that.
But I think it's easier to think of it with
the other sort of direction they give out what operating cash flows are.
Operating activities generally involve producing
and delivering goods and providing services.
If you think about why does your firm operate?
Well, they operate to sell books or to make T-shirts or to
make coffee and any of
those primary things would show up in the operating activity section.
Generally, the cash effects of
operating transactions are things that also impact net income.
Let me give you a few more examples.
Cash from operations would include cash receipts from the sales of goods or services.
So when we sell that book or we sell that cup of
coffee that would be an example of something that would going to operating activities.
It also includes cash payments to our suppliers or employees.
So when we pay our supplier for having given us
that book or when we pay our employee for having made that cup of coffee,
we would say that's a core part of our operations
and so it's going to go into our operating cash flows.
It also includes cash receipts from dividends or interest earned.
The idea here is that these occur during this operating cycle.
We held a certain stock during the cycle.
And so we got a dividend on it,
so it's part of this period's operation.
Now to show you there's some kind of strange things in here too.
It also includes cash receipts or payments for lawsuit settlements.
Doesn't matter when the lawsuit actually was created
but whenever we get the settlement or pay the settlement that shows up in operating.
This is one of those things that falls into that category of,
it wasn't financing and it wasn't investing.
So I guess we'll call it operating.
There's one other example I want to give you.
When we make cash payments to people who have lent us money that is
when we make an interest payment we put that in operating activities.
What? Why don't they go in financing?
If you've got a whole section for financing and you're paying interest to
people who loaned you money that sounds like financing.
Well the idea here was it was what we paid to have that financing this period.
So it's the interest of this period just like
the reason that we took the dividends and
interest that we earned to go in in this period.
It's considered part of the operating cycle.
Not everybody agreed with that when those standards were set in the U.S.
It was actually a split vote.
And in fact, under
International Financial Reporting Standards those cash payments to lenders,
those will usually end up down in your financing section.
They understood the arguments made by the
U.S. that hey that's part of operating the cycle.
But they also understood the argument that
hey it's something that I'm paying for have financing.
It's one of these judgment calls.
You can see even though we think using cash will get us away from them. They don't.
Any time we're going to start classifying things
we're going to have to make some decisions about how we treat them.
So just remember in the U.S. if we make
a cash payment to a lender for
interest that's going to show up in our operating activities.
In most other countries that's going to show up in our financing activities.
OK. Let's Move on to the next section now.
Cash flows from investing activities.
These activities are cash flows that occur from making and collecting loans,
acquired and disposing of debt where you're loaning
other people or getting a payback from other people,
having purchased an equity instrument,
buying property plant and equipment etc.
Good way to think of these are it's cash that we used up
this period and we think we're going to get benefits over future periods.
If this were in accrual accounting statement they would say exactly how many periods?
Forecast it out.
Start to think about how we're using that property plant and equipment up.
How much for each period etc.
The cash flow statement says look I'm
not going to make any of those sorts of judgment calls.
All that I'm going to tell you is this is cash
that I've spent that I think I'm going to get
a long term payoff out of something longer than
a year or if it's cash that comes in it's going to say,
this is cash that came back from something that I
had originally invested in thinking it was going to have a long term payoff.
If you see cash coming back from this category then what you know as we've gotten rid of
something we expected to be given us
long term payoffs and you might want to think about what that means for the firm.
Let me give you a couple of examples of cash from investing activities.
Cash flows related to the purchase or sale of PP&E.
If you buy a factory that's gonna have a long term payoff.
If you paid cash for it,
it would show up in our investing activities.
If you sell a factory,
well that's money that came in from something you expected to have
a long term payoff that would show up in our investing activities.
Similarly, if we purchase or sell a long lived intangible asset,
say a trademark or some sort of brand name,
any of those sort of assets also are assets that we expected to have a long term payoff.
So they're going to show up in our investing activities.
Similarly, if we invest in some sort of marketable securities,
you know we buy stock in another company.
Well we're going to put that down in our investing activities.
We took some money we had,
we turned it into something that we anticipate we may hold for a while.
And so that's an investment.
With the same sort of thought process we do the same thing if we loan money to
somebody else or if they pay back money that we had lent them in the past.
Again we lend that money to say
another company under the idea that it's
an investment that's going to pay off over the longer term.
It's not part of our core business.
For example if we're a company that sells books but we lend money
to another company they're going to use it to say
build their headquarters and they're going to sell screws.
We don't want that to be part of our operation.
But when we made that loan to them we expect to be paid off over multiple periods.
And so we're showing that we've made an investment
that we're expecting a return to in the future.
OK. Let's move on to our financing activities now.
Financing activities include any sort of obtaining resources from
our owners or any sort of borrowing money for our own firm.
It also includes repayments to the borrower of the principal.
But remember it doesn't include the interest.
In fact, my bullet points are going to show you just that.
When we issue or repurchase common stock,
the money that we get from the issuance or the money we use
up for the repurchase shows up in investing activities.
When we pay dividends to the owners,
that's again a payment related to our financing and so
that's going to show up in the financing activities.
Finally, when we issue debt or when
we pay back the principal on debt whether we call it a bond or a note payable etc.,
that's going to show up in the financing activities as well.
Just remember we're not going to put the interest in here.
Well that pretty much covers it for the categories of the cash flow statement.
We'll take a look at how to actually apply these to some statements in some other videos.
Greg MillerProfessor
