Cash Flow Statement

Quick reference

• 00:04 The third and
• 00:05 sort of least of the financial statement types is the cash flow statement.
• 00:09 That's because the income statement and the balance sheet, the first two,
• 00:13 were known as the primary financial statements for a long time.
• 00:17 And cash flow statement was just a note to the accounts.
• 00:20 What's happened with lots of prominent collapses over the years due to
• 00:25 cash fraud, the cash flow statement has become more prominent.
• 00:28 And therefore has become a financial statement in its own right,
• 00:31 showing how changes in income statement to balance sheet affect the cash of the bank.
• 00:34 It has been split into three parts, before I go any further,
• 00:39 let me make an important point.
• 00:42 I want to stress that as human beings, regardless of whether we're accountants or
• 00:47 not, we do tend to think in P&L terms.
• 00:49 Let me explain, there's two fundamental types of accounting that's out there.
• 00:55 The first type is accrual-basis accounting, so for
• 00:58 revenue that means it's recognized when products are delivered, or
• 01:01 services are provided, or a contract goes unconditional.
• 01:05 On the cash-basis accounting approach it's not revenue,
• 01:09 it's cash receipts are recognized when monies are received.
• 01:13 Now I'm talking about revenue and cash receipts here,
• 01:15 but could be talking just as easily about costs,
• 01:17 like cost of goods sold or operating expenditure, and cash payments.
• 01:21 Same idea other way around.
• 01:23 This gives rise, therefore, to timing differences.
• 01:27 You've got the difference between the accrued revenues and expenses, and
• 01:30 the deferred revenues and expenses.
• 01:32 So what I'm talking about here is that, for accrued revenues and expenses,
• 01:36 these are things that actually are in the period where the money may not yet
• 01:40 have been received.
• 01:41 Whereas a deferred revenue expense is where you actually received the money, but
• 01:46 you've not yet earned it.
• 01:48 So you might have been paid in advance, that sort of thing.
• 01:50 In the recognition criteria,
• 01:52 we have these timing differences between as incurred, and may differ in time.
• 01:57 I've got to consider that when moving forward.
• 02:01 So the idea here really is that there's fundamental concepts at play.
• 02:05 The recognition of revenue and expense items as they are earned or incurred,
• 02:09 is accruals not a cash basis.
• 02:11 So you've got interest expense versus interest paid.
• 02:14 We've also got the idea that depreciation, I've talked about time and again already.
• 02:18 About expenses are allocated to a period, even though they may only be
• 02:22 incurred in one period, we spread it over a period of time.
• 02:25 Because it's actually better to allocate it with their associated benefits as
• 02:29 they're derived, such as depreciation of non-current assets.
• 02:33 They serve different, important purposes, people understand earnings,
• 02:38 provides an idea of the operational profitability of a business.
• 02:41 Whereas, ultimately, cash is cash is cash, and we just split it into different parts.
• 02:48 So be careful, revenue is not equal to cash receipts,
• 02:52 operating expenditure does not equal cash payments, and so on.
• 02:57 Let's have a look at the cash flow statement then.
• 03:00 So with operating cash flows we have four key elements,
• 03:04 the cash receipts, cash payments, interest paid, and tax paid.
• 03:08 Typically only cash receipts is a positive number here.
• 03:12 And typically the other three will be shown as negative numbers,
• 03:15 although I've not shown it as such here.
• 03:18 Investing cash flows?
• 03:19 Yes, it can be your interest received and any dividends received,
• 03:23 plus the purchase of capital and any disposals.
• 03:26 And that will give you your net investment cash flows.
• 03:28 And financing is just all the funding, debt drawdowns,
• 03:31 repayments, the equity issuance, buybacks and dividends paid.
• 03:34 Now a few pointers here.
• 03:37 Interest paid, if you think about it,
• 03:40 a lot of people think that should be in financing.
• 03:44 Strictly speaking, that's not true.
• 03:45 And there's two reasons for this really.
• 03:48 The first is that the interest paid is servicing mandatorily
• 03:52 the actual debt that is used to borrow to expand a business.
• 03:57 So it's part of the operating activities, hence in operating cash flows.
• 04:01 If that doesn't float your boat, think of it this way.
• 04:03 P&L is your net operating profit after tax.
• 04:08 Is interest expense in the P&L?
• 04:10 Yes, therefore interest paid is in operating cash flows.
• 04:14 Bit of a dodgy link but that's the way that lots of people get over the line.
• 04:19 Now with investing cash flows, interest received is not always here.
• 04:23 If it's a bank for instance it might be the cash receipts because it's going to
• 04:27 be the money received from loans.
• 04:30 So be careful it has to be a non bank would have the investing cash flows here.
• 04:33 As money lying around earning interest.
• 04:36 Dividends paid on hand confusingly isn't finance in cash flow,
• 04:39 because is not a mandatory servicing of equity.
• 04:42 You don't have to pay a dividend, it's a financing decision.
• 04:46 And because it is a financing decision it's a financing cash flow,
• 04:51 and that's the idea here.
• 04:52 Ultimately cash is cash is cash.
• 04:53 It has been thought of in the past as an afterthought.
• 04:57 But really, it's an idea of reconciling the cash movements for a period of time.
• 05:01 Now, there are two versions of a cash flow statement, the direct and the indirect.
• 05:05 And it relates to the presentation of operating cash flows,
• 05:08 the rest remains the same.
• 05:10 Let me explain.
• 05:13 With the direct, the operating cash flow is going to be your cash receipts,
• 05:18 less your cash payments, less interest paid, less tax paid.
• 05:23 And that is called direct really,
• 05:25 because you can reconcile it directly to your bank account.
• 05:29 The indirect method is favored by modelers.
• 05:31 And this is why it's important to mention this.
• 05:33 What you've got here is you start off with a P&L item which might be something like
• 05:38 net profit after tax.
• 05:39 You add back your noncash items, which is depreciation, interest expense and
• 05:43 tax expense.
• 05:44 You put through your movements the actual adjustments in current assets and
• 05:49 current liabilities the debtors and creditors as they were.
• 05:53 Which reconciles the revenue to the cash receipt, and
• 05:56 the expenses to the cash payment.
• 05:58 So it's the adjustment, the bit you have to go through.
• 06:00 And then you having added back the noncash items, you deduct their counterparts.
• 06:07 So instead of interest expense, you put through interest paid.
• 06:10 Instead of tax expense, you put through tax paid.
• 06:13 But instead of depreciation, you don't do anything.
• 06:17 And the reason for that is not only is it a noncash item.
• 06:20 But it's also a double count.
• 06:23 The cash equivalent to depreciation is actually the purchase of capital items.
• 06:28 Which is actually an investing cash flows already.
• 06:30 So it's a double count.
• 06:31 So we add it back A because it's a non-cash item, and B,
• 06:35 because it's a double count.
• 06:37 And the two numbers have to be equal.
• 06:40 You'll see the net operating cash flow and both methods give the same number.
• 06:43 It must, if your model doesn't do this, it's wrong.
• 06:47 And when we do the exercise in a bit we will actually make sure we reconcile and
• 06:51 show that we can generate it both ways.
• 06:53 Now the way we should model is the direct method, and
• 06:56 I'll explain that when we talk about control accounts.
• 06:59 It gives you more information.
• 07:02 But we will show the indirect model as well,
• 07:03 because that's what a lot of people prefer.
• 07:06 So be very, very clear about this.
• 07:08 That we've got these two different methods of cash flow, direct and indirect,
• 07:11 which are both important.
• 07:13 Direct helps your balance sheet balance.
• 07:15 Indirect helps people or modelers understand their models.
• 07:19 Let's move on.

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