Locked lesson.

Upgrade

About this lesson

The Cash Flow Statement is a financial report that shows how well the company was able to convert business activity into cash over some time period.  This lesson will focus on sources of cash.

Exercise files

Download this lesson’s related exercise files.

Cash Flow Statement Part 2.docx
148.4 KB Cash Flow Statement Part 2 - Solution.docx
60.7 KB

Quick reference

Cash Flow Statement Part 2

The Cash Flow Statement is a financial report that shows how well the company was able to convert business activity into cash over some time period.  This module will focus on sources of cash.

When to Use Cash Flow Statements

Cash Flow Statements are calculated for some time period, typically a month, quarter, or year.  It is often used in conjunction with the Earnings Statement and Balance Sheet to ensure a complete picture of financial health of a company.

Instructions

  • The Cash Flow Statement is focused on the generation and use of cash.
  • The Cash Flow Statement starts with the Net Income for the time period as calculated on the Earnings Statement.
  • The Cash Flow Statement looks at the change in the balance of business accounts over the time period to determine if they reflect a source of cash or a use of cash.
  • The Net Cash Flow is added (or subtracted) from the original cash balance at the start of the period to determine the ending cash balance.
  • The Cash Flow Statement categorizes the accounts into three categories: Cash from Operating Activities, Cash from Investing Activities, and Cash from Financing Activities.
  • Operating Activities can become sources of cash if the business has been able to manage the operation well.  This category starts with the Net Income earned during the period. 
  • Then changes to the amount of money in the operating accounts of Inventory, Accounts Receivable and Accounts Payable can become sources of cash. 
    • A decrease in Accounts Receivable is a source of cash since the company is collecting cash from customers faster.
    • A decrease in Inventory is a source of cash since there is less money needed to buy parts and store them on shelves.
    • An increase in Accounts Payable is a source of cash since cash has not been sent to the suppliers.
  • Depreciation is added into the Cash from Operating Activities because the Net Income in this category has been decreased by the depreciation charge on the Earnings Statement which represents a portion of the value of investments.  Since the cash to purchase the investment has already been accounted for in the Investment portion of the Cash Flow Statement, it must be added back to prevent double counting.   More on this when we discuss capitalization and depreciation.
  • Investing Activities are seldom a source of cash.  The only time this is a source of cash is when an asset that the company invested in has been sold.  This could be either a physical asset or a financial asset.
  • Financing Activities can be a source of cash.  However, as operating managers, we seldom are involved with financing activities.  These activities will generate cash in several ways:
    • Short-term loan – borrowing money that should be paid back within one year.
    • Long-term loan – borrowing money with a term of longer than one year to pay it back – usually from a bank or lending institution.
    • Issuing bonds – borrowing money from investors with a commitment to pay it back a certain time.
    • Issuing stock (or a percentage of ownership in the company) – receiving money  but acquiring additional owners are providing a larger share of the company to an existing owner. 

 

Hints and Tips

  • Many companies will subdivide some of these accounts for greater insight.
    • Receivables from product sales and receivable from financing product sales.
  • Do not confuse cash with profit.  You can increase cash and kill the business, or you can show a great deal of profit and run out of cash – especially in an accrual business.
  • There are often both sources of cash and uses of cash in each of the three categories.
Login to download
  • 00:02 Hi, I'm Ray Sheen.
  • 00:04 I've already introduced the cash flow statement, but
  • 00:07 now I'd like to go deeper into the sources of cash.
  • 00:09 Recall that the cash flow statement showed all the sources and
  • 00:14 uses of cash that occurred within a time period.
  • 00:17 Sources are positive numbers, and uses are negative numbers.
  • 00:22 Some categories could be either a source or
  • 00:24 a use depending upon what had happened in the business during the time period.
  • 00:29 All of the sources and
  • 00:29 uses are added together to determine a number called net cash flow.
  • 00:34 When that number is added to the cash balance available at the beginning of
  • 00:37 the period, It shows the cash balance available at the end of the period.
  • 00:41 The cash flow statement is divided into three categories,
  • 00:45 cash from operating activities,
  • 00:46 cash from investing activities, and cash from financing activities.
  • 00:50 I want to go through each of these categories with a focus on
  • 00:53 sources of cash.
  • 00:54 I will be discussing the types of sources.
  • 00:57 Most companies will actually have several sub-accounts in each category on their
  • 01:00 cash flow statement.
  • 01:04 The first category is cash from operating activities.
  • 01:07 These activities are the normal business operations of the company.
  • 01:11 Many of the accounts you see here will also show up on the balance sheet or
  • 01:14 earnings statement.
  • 01:16 They reflect the impact on cash based upon how well the business manages
  • 01:20 the processes of making, distributing, and selling products or services.
  • 01:24 When managed well, these will often be sources of cash.
  • 01:28 When not managed well.
  • 01:29 These can become uses of cash.
  • 01:31 Lets take a look at the major type of accounts in this category.
  • 01:34 It normally starts with the net income from the earning statement.
  • 01:37 And since we are discussing sources of cash, we can assume we had a profit.
  • 01:42 The next item I want to mention is changes in accounts receivable.
  • 01:45 A decrease in this account will create a source of cash.
  • 01:49 Often this decrease is because the average amount of time to pay has reduced.
  • 01:54 The company is getting the cash faster from customers.
  • 01:57 The next item is changes in Accounts Payable.
  • 02:00 In this cas,e an increase in this account creates a source of cash.
  • 02:04 The company is not using its cash to pay its suppliers as fast as before.
  • 02:08 So there is more cash available.
  • 02:10 We follow this with changes to inventory.
  • 02:13 A decrease in inventory is a source of cash.
  • 02:16 Inventory sitting on a shelf in the stockroom or
  • 02:18 a distribution center is money tied up on a shelf.
  • 02:21 If we sell all that inventory, we have more cash.
  • 02:25 The last item in this category is depreciation.
  • 02:28 We'll talk more about this in another module.
  • 02:30 But let me explain why it is here on the cash flow statement.
  • 02:34 The depreciation charge is an operating expense on the earning statement, so
  • 02:37 the net income is lowered by the amount of depreciation.
  • 02:40 Now depreciation represents the cost of acquiring fixed assets.
  • 02:44 We're going to reflect that cost In the cash from investing activities.
  • 02:48 So we need to eliminate the effect of that cost in the cash from operating activities
  • 02:53 or we would be double counting it.
  • 02:55 That is why we add depreciation back in on cash flow statement.
  • 02:59 So let's talk about the category of cash from investing activities.
  • 03:03 Investing activities are those associated with buying assets, usually fixed assets.
  • 03:08 These fixed assets are recorded as such on the balance sheet.
  • 03:11 They represent money that is spent to increase the capacity or
  • 03:14 capability of the organization.
  • 03:16 Occasionally, this section will include financial investments
  • 03:19 that the business makes.
  • 03:21 The only way for this category to be a source of cash for the current period
  • 03:24 is by selling an asset whether it's a fixed asset like a building, equipment or
  • 03:29 financial asset like stocks or security if sold it becomes a source of cash.
  • 03:35 The third category is cash for financing activities.
  • 03:38 Financing activities can be another significant source of cash.
  • 03:42 They're activities associated with the use of debt and equity within the business.
  • 03:46 In other words, the right side of the balance sheet.
  • 03:49 As operating managers,
  • 03:50 we normally don't have anything to do with this type of activity.
  • 03:53 These are handled by the finance organization and
  • 03:55 the senior management of the company, but we should at least beware of them.
  • 04:00 There are several ways we can raise cash with financing.
  • 04:03 Two fo the easiest to understand is that we can get cash by borrowing it
  • 04:07 using either short term debt or long term debt.
  • 04:10 The difference between those is the term of the loan.
  • 04:12 From a cash flow standpoint, we don't care what type of debt it is.
  • 04:17 Another source of cash is to issue corporate bonds.
  • 04:20 The individuals and institutions who buy the bonds pay the company cash.
  • 04:25 And the company that pays back the cash and some interest over a specified time.
  • 04:29 The final source of cash in this category is to issue more stock.
  • 04:33 Cash is received from those who wish to buy the stock.
  • 04:36 This increases the number of owners and
  • 04:39 may dilute the distribution of profits, but it can create a lot of cash.
  • 04:45 Well, those are the sources of cash.
  • 04:47 When operations is able to generate a lot of cash,
  • 04:50 they can use that money to either spend it on investments or pay off debt.
  • 04:54 When operations is not able to generate a lot of cash, investments have to be
  • 04:58 reduced and the company may be forced to borrow money just to pay its bills.

Lesson notes are only available for subscribers.

PMI, PMP, CAPM and PMBOK are registered marks of the Project Management Institute, Inc.

Gift this course