Welcome everyone to the third week of our accounting course. This week, we'll talk about two fundamental topics, the statement of cash flows and the analysis of financial statements. The first part will be devoted to the statement of cash flows and then the second part to this analysis. So these two things they seem to be closer to what we are doing in our evaluation processes. Well, let's start with the statement of cash flows. And here, we have the idea and format. Now the story here goes like this, that we could have used cash basis accounting. All transactions we could have recorded with the use of cash and cash equivalents only, but we talked about that in the first week. This does not produce a good estimate of our activities and good description of our activities. For this reason, now we are trying to reconcile or combine the two and see why the statement of cash flows, and how it's linked to other financial statements. Well, the story goes that companies may run negative incomes and this may be bad, but that does not immediately result in the failure of the company. However, if you fail to pay your bills, then that does result in you complete failure. So cash is really king and is important. Now, I would say a few words about the format of the statement of cash flows. It consists of three major parts, operations, investment and financing. So basically, we first study cash produced, hopefully, by operations then cash normally used in investment and cash raised in financing, and then the result is net change in cash. So now a few words about what cash is. Well, cash normally is currency, demand deposits and some other deposits equivalent to them. And then cash equivalents. These are short term liquid securities like commercial paper, treasury bills, money market mutual funds and so on and so forth. Now let's see this format that is important for us. So we will study what these areas of activity consist of and how they effect change in cash. We will first start with operations. Well, operations is everything that is aimed at production of goods and services. And finally that contributes to the profit generation and cash generation. So here we see these all transactions aimed at production, sales of goods and services and so on. Now what are inflows here? These are sale proceeds and, let's say, interest and return on short term investments. Because these short term they don't go to investments here so for one period, for example. And what are outflows? These are various payments, payments of all kinds, taxes et cetera. Well, this is pretty clear what it is actually. And hopefully operations they do produce cash. So if the company works nicely, then it produces a lot of cash. Well, examples are plentiful. So many companies producing, even companies in new economy like Apple for example, they are very much cash flow and they keep producing lots of profits and lots of cash. Now goes investments. Well, first of all, why do we make investments unless we are an investment company? Well, because investments they feed our operations. What goes here? So this is I would put right away inflows will be, let's say proceeds of loan repayment. And, let's say, asset sale. But investments mostly are outflows. So these are purchase of property, plant and equipment. And then, let's say, loans made, and various other long term investments made. So this is all outflows. So here, look what happens. We have investments that we make. And then over this period of time we do something else to feed our operations. And these are normally negative. These are hopefully positive. But what if for- So where do we get the money to make investments? Well, if the company is nice and produces lots of cash, you can say well we've made that much cash last year so we took part of that and made investments. But most often there is an important component of that that is financing, and all companies start with that. So we cannot go without this. What is financing? Well, it's clear from it. So this is funds from owners and various kinds of borrowing. This is the old roll idea. And again, inflows are proceeds from issue of bonds and stocks. And also let's say loans received, let's say venture capital inflows. What are outflows here? Let me complete that, inflows. Well, these are dividends paid. These are shares repurchased and these are loans repaid, and then let's say bonds redeemed. So basically, this is pretty clear. So what I am trying to say here, wrapping up this episode is that this format actually provides a much better information about a company than just the balance of cash flow. Because you may have negative operations. So we keep losing money. And you make significant investments and these investments are bad. But if you take someone else's money, by the process of financing, the overall cash position may be positive. So unless you go further and divide that up in these three areas, you may misjudge what the company is doing and that is important. For example, many startup companies they make lots of investments and they run negative income operations. So they are afloat only because of heavy financing. So initial investors they put a lot of money in these companies and if they grow fast, fast growth clearly includes massive investments. And you still can keep losing money in your operations, but all your cash balance will be positive. So that is why this form of the cash flow statement is so important to properly describe the company. Now we can talk about that for a long period of time. But instead what we will do in the next three episodes, we will go over some examples. First, shorter and more simplistic examples. And episodes three and four, this is one example but this is comprehensive and long, for that reason I broke down in two pieces. So let's embark on the analysis of statement cash flows on examples.
