Purpose of Statement of Cash Flows - Cash Flow Statements, Cost Accounting Video Lecture | Cost Accounting - B Com

in this video we're going to talk about
the purpose of the statement of cash
flows so investors have a tendency to
fixate on net income they say what's the
bottom line is this company profitable
they calculate things like ROA ROI but
it's important to remember that net
income is an accrual based number that
means that there are certain things in
net income that we hope will map into
actual cash flows at some point in the
future but may in fact not so for
example you make a sale on credit you
debit accounts receivable you credit
sales and this is going to increase your
net income however what if you don't
collect these accounts receivable right
if it doesn't actually turn into cash
flow that could lead to serious problems
for your firm and that's led to a lot of
people saying things like cash is king
and what they mean by that is the
following so a firm doesn't necessarily
go bankrupt when it posts a loss or post
a series of losses firms go bankrupt
when they run out of cash so cash flow
is the most important thing for a
business and so the statement of cash
flows is going to tell us basically
where the firm's cash comes from what
are the changes in the firm's cash
during the period whether sources and so
forth so it's a really important
statement understanding of firm's
liquidity so if we look at just a basic
structure of a statement of cash flow
we're going to have the change in cash
flow but that's not as important because
we could have seen the net change of
cash flow if we just look at the balance
sheet last year and then the balance
sheet this year we could see what
happened to the cash account so it's not
just that we see the change in cash flow
it's the bit what is by breaking it out
into cash flow from operating activities
cash flow from investing activities cash
flow from financing activities when we
can look at these different things we
can say okay where is the cash coming
from and where is the cash going to with
this business so let's walk through an
example to make it a little bit easier
for you to understand so let's say we've
got a company called fast money
Technologies and that they have net
income of 1.2 million dollars so this
company is profitable right so they have
a positive net income so people might be
excited and say hey that's a company
worth investing in and we look at let's
say we look at last year's balance sheet
and we look at this year's balance sheet
and we see the hey cash account actually
went up twenty-five thousand dollars so
now things are pretty looking pretty
good right we've got a profitable
company and their cash is actually
increasing so it doesn't look like
there's any problem with cash flow right
well that's where we want to do a
statement of cash flows and see exactly
what's happening so here's just a really
brief eiated statement of cash flows and
I just have the the three main things
here we've got our cash flow from
operating activities cash flow from
investing activities and cash flow from
financing activities okay so when we
look at the CFO the cash flow from
operating activities we see it's a
negative two hundred and seventy five
thousand dollars see the fact that I've
got it in parentheses here means it's a
negative number or a use of cash so that
means that when we just look at the cash
generated by the operating activities it
was actually negative so the operating
activities used up cash right so the net
effect was a use of two hundred and
seventy five thousand dollars of the
firm's cash so you might say hey wait a
minute wait a minute how is it that we
can have 1.2 million dollars in net
income and then our cash flow from
operations is negative negative two
hundred seventy five thousand well
that's because net income includes
accruals right remember like we just
talked about let's say that you had a
bunch of sales that we're on credit and
so you have a really high accounts
receivable balance that's going to boost
your your net income as you make all
those sales right but now into you
actually collect those sales right you
don't have any cash flow from operations
so this is just reflecting the
difference between this accrual-based
number and then this cash base number
here right so there are any number of
reasonable to pin inventory and so forth
but in any event we've got this cash
base number year's cash flow from
operations is negative and then we've
got a positive profitability number and
now so you say well how is this firm
staying if they haven't if they're
generating negative cash from their
operations how are they staying afloat
well they don't have anything going on
with their investing activities but if
we look at our financing activities they
have $300,000 positive cash flow
provided by their financing activities
and let's say that we take a look a
little bit we look a little deeper and
we see that that's from a loan so they
borrowed money
from a creditor right so they borrowed
money from a bank or so forth they
borrowed $300,000 and so that's what's
accounting for this increase in cash so
if we just look the comparative balance
sheets we'd see Oh from last year's
balance sheet to this you've gone see we
went up $25,000 everything might be
going wonderful but now we see that well
you know we do have cash everything's
fine right but we got $300,000 of it
from the bank right so the bank give us
that money we're not generating it from
our operations we're actually losing
money from our operations we're losing
cash now it doesn't mean necessarily
just because you have negative cash flow
right now that the company's a bad
company and you shouldn't invest and so
forth it might be the okay they collect
all those receivables next year and
everything's fine
but we this is kind of like a red flag
right we want to take a look and say
wait a minute wait a minute do we think
that all these this net income the
accruals are actually going to map into
cash flow and do we think for example at
this firm with this loan do we think for
example that they'd be able to meet
their first interest payment or are they
going to have to come back and borrow
more money from a bank or borrow or
raise money with the stock issuance or
something right are they going to have
to get equity so basically we have to we
have to think about these things right
they have a loan so now they're going to
have an interest payment right and so if
they're not generating positive cash
flow next year so let's say next year
cash flow from operating activities is
also negative then that means that
they're not going to have the cash from
the operations to make the interest
payment on this loan so what does that
mean that means they're going to have to
go again and say okay well we've got to
borrow more money from the bank and this
or or do that on a stock issuance or
something like that but what if the bank
says look we're not going to lend you
any more money or what if you know
credit dries up or so forth then they
might say well in this investing we
could sell off some of our assets or
something like that but you really want
the company selling off its machinery
and so forth to you know pay this loan I
mean they use the machinery to generate
ideally cash flow from operations so
it's just something to think about and
remember that the statement of cash
flows isn't just telling us about about
the change in cash right we don't want
just no delta cash we can get that from
parrot of balance sheets is telling us
what happened what happened and why
right so we're seeing the sources we're
seeing that this firm is not generating
cash from its operations it leaked out
right now they're actually just being
they're getting all their cash from
financing so just because they've
increased cash and they've got positive
net income doesn't mean that this firm
isn't going to go bankrupt right it'd
just go very easily be that they don't
generate any cash flow from operations
next year or the year after that either
and at some point the bank says we're
not going to loan you any more money and
they just run out of sources of cash and
then when the firm runs out of cash they
go bankrupt regardless of whatever
accrual-based net income number they
happen to Jenny