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Billing statement template for Operations

Today we'll talk about the cash flow statement. It's one of the three main financial statements, but often overlooked. Sure, the income statement provides information on revenue and profits over a certain period of time, and the balance sheet gives a snapshot of the financial health at a certain point in time. But it's the cash flow statement where you can find out how effective a business is in managing its cash, and what it spends it on. And in the end, cash is the lifeblood of any business. If you can't pay your employees, your vendors or your taxes anymore, it's game over. (computerized electronic music) So let's get started. (upbeat music) In a previous video we talked about the difference between cash and accrual accounting. We said it's important to understand that profits and cash can be two different things. Profit is defined as revenue minus expenses. And in accrual accounting we report revenue when it's earned, and expenses, when they're incurred. But earning revenue doesn't always increase cash immediately. And incurring expenses doesn't always decrease cash right away. Remember this important difference to cash accounting. If you want to find out how much cash a business has, you could just look in the balance sheet. There you're going to be able to see if the cash position has gone up or down. But this way you won't see how the cash came into the business and maybe even more importantly, what it was spent on. Therefore, to get a complete picture of the business, we also need to look at its cash flow statement. Just think of this as a report that shows you how cash was entering or leaving the business. If you see a positive figure, it means cash came into the company, and negative figure means cash left the business. A cash flow statement looks like this. It consists of three main parts. The first one is the cash flow from operations. This is the most important part, because it shows you how much cash is generated with the actual operations of the business, meaning by selling the company's products and services. Then, we have the cash flow from investing activities. As the name says, this is either cash spent on investments or cash received from sales of investments. In other words, it's outside of the primary business activities of selling products and services. In this section we can see if the company purchased assets like machinery and equipment, or maybe even acquired another business. Last one is the cash flow from financing activities. This section summarizes cash transactions that involved raising, borrowing and repaying capital. For instance, here we can see if the company issued new shares, if dividends were paid, if a bank loan was taken out, or if a debt principal was repaid. At the very bottom of the statement you see the reconciliation to the balance sheet. It shows you the starting point of cash from the last period and the ending balance from the current balance sheet. The difference between the two is the net change of cash which has to equal the sum of the three cash flow sections above. In other words, beginning balance of cash, plus the cash flows from operations, investing and financing must equal the ending balance from the current balance sheet. Let's look at the three main sections in a bit more detail. First, cash flow from operations. To calculate cash flow from operations, there are two different methods in use. One is the indirect method which takes net income from the income statement as starting point. But we already know income doesn't equal cash. So in order to arrive at a cash flow, a lot of adjustment lines must be added. Therefore it's not the most intuitive method to understand. The other one is the direct method which doesn't start with a net income, but instead lists different types of transactions that produce cash amounts received and paid. For instance, it will have lines like cash received from customers, cash paid to suppliers, to employees or interest and taxes paid. GAAP and IFRS allow both methods, and both will get you the same result. While the direct method is easier to read and provides a better insight, it's very time-consuming to prepare. The indirect method on the other hand, is linked to the P&L and balance sheet. It's less intuitive, but it's much easier to prepare, which is why most companies use this method. So, we're going to skip the direct method and only concentrate on the indirect method in this video. As we said, we start out with net income, which is taken directly from the income statement. Then, we adjust net income for multiple effects to arrive at the cash flow. Let's look at the most common ones. Depreciation and amortization, these are expenses in the income statement that don't have any impact in cash. We call this a non-cash transaction. Think about it, when we account for the wear and tear of using an asset, no cash leaves the business. It's just how we allocate the expenses over the useful life of the asset. The only time cash is affected is when we actually buy the asset. But depreciation and amortization reduce net income. And since net income is the starting point up here, we need to add this expense back. Same goes for the gain or loss on the disposal of non current assets. Let's say the business is selling a forklift, which it acquired for $10,000 two years ago, but now doesn't need it anymore. And let's see the current asset value of the forklift is 5,000 because the company has been using it for two years, in its warehouse. The company is able to sell it for $8,000. What we'll see in the income statement is a gain on the disposal of the forklift of $3,000. But in the cash flow statement we want to see the full cash impact, not the profit on the disposal. So we need to take away the 3,000 included in net income above and show the full $8,000 cash in. But since selling off equipment is not part of the ongoing operations of this business, we're not going to show $8,000 cash in here, but further down in the section for cash flow from investing activities. Next is the adjustment for changes in working capital, which merely consist of inventory, receivables and payables. To understand why we need to adjust for these balance sheet items, you need to think about how these positions influence the amount of money the company has in the bank. First, inventory. Let's say at the end of last year, your inventory value in the balance sheet was 100, and now it's 150. It increased by 50, which means you're keeping more inventory in stock. And you had to pay for this increased inventory, so more cash was living the business. Is this increase reflected in the starting point up here, the net income? It's not, right? Net income just includes the expenses for cost of good sold, but not if you're buying more inventory than you're selling. That's why we need to adjust for it here. A higher inventory means cash is decreasing, a lower inventory would increase it. Next, receivables. These work the same way. Let's say you're selling someone products for 100, but on credit. You didn't receive the cash yet. In the income statement under the accrual method, we would show the earned revenue, which increases our net income. And our starting point would include the 100. However, cash wasn't received, was it? We are still waiting for the cash. So, if accounts receivable increase, we adjust with a negative number. If they're lower, we adjust with a positive figure. Then, payables. They work the other way around, because of the liabilities. If we increased this position, we paid out less to our suppliers. We're working with their money, which is good for our cash balance. So a higher figure for payables is a positive cash increase in change. If they decrease though, it's negative for a cash balance, because we use more of our cash to pay the suppliers. Now, all that's left to do is to sum up these adjustments with net income on top to get to the cash flow from operations. Obviously, Microsoft's cash flow is huge, but even if you look at a smaller company, you want to see a positive number here. Otherwise, the business is not generating cash, with its core business, which should raise all kinds of red flags. Another important thing to take away here is the crucial role of working capital for most companies. If you keep a lot of inventory, grant long payment terms to your customers or have a lot of overdue receivables, you're using a lot of cash to finance that. Cash, which you then don't have to add capacity, expand to new markets or invest in marketing. Now speaking of investing, let's talk about the next section in the cash flow statement. Cash flow from investing activities. Remember when we adjusted for depreciation and gain or losses from sale of assets before? The reason was that these were non-cash transactions. They don't affect your cash balance. What does affect it, though, is the cash in or outflow when the business is buying or selling these assets. And that's exactly what we see here. When a company purchases new property or equipment, we will see the full cash outflow in this section. Likewise, if it acquires a company or other investments, we're going to see that they're here too. Last part is the cash flow from financing activities. This section summarizes the cash transactions that involve raising, borrowing and repaying capital. So just to make this clear, let's look at an example and how it affects this section of the cash flow. When a company borrows money from a bank or issues bonds or shares, it receives cash. This cash will be reported as a positive amount in the cash flow from financing activities. A positive amount informs the reader that cash was received, which increased the company's cash balance. On the other hand, when a company repays the principal portion of its loans, purchases its own shares or pays dividends to its owners, the amount of cash used will be reported as a negative amount here. The negative amount informs the reader that cash was used which reduced the company's cash balance. All right, so these are the three sections of the cash flow statement. It's important to be able to distinguish among these elements, as it's going to give you a good idea of where the company makes and spends its money. And as we've seen in the beginning of this lecture, the sum of these three types of cash flow gives us the company's change in net cash for the period. The net cash flow is the difference between the amount of cash the company had in the beginning of the period, versus the amount of cash it had at the end of the period. I hope this video was helpful to better understand the cash flow statement. If you enjoyed it, please give it a thumbs up. And if you want to improve your skills, consider subscribing. And don't forget to hit that bell, so you don't miss any new videos. Thank you for watching, and I'll see you in the next video. (upbeat music)