Hi everyone, in our last lesson I mentioned we would discuss a financial statement that often gets less attention than the balance sheet and income statement. Well, I have a surprise, I'm actually going to discuss two statements, the bulk of today's lesson will be spent on the statement of cash flows. But I want to start our lesson by making you aware of something called the statement of comprehensive income. For companies that report comprehensive income, the statement of comprehensive income can be found either as an extension to the income statement or shown separately and consists of really two items net income and other comprehensive income. We spent the last three lessons discussing that income, so I'll skip the review of net income but what is other comprehensive income? Too much detail about other comprehensive income is probably beyond the scope of this course, but I will make a few points. First, companies that hold investments in other companies might have other comprehensive income related to changes in the value of those investments. Second, companies that offer employees a pension for retirement, may have other comprehensive income. Third companies who have significant operations outside of their home country might have other comprehensive income. Importantly, if companies have no other comprehensive income items, they aren't required to prepare a statement of comprehensive income. So neither Jed nor missy prepares a statement of comprehensive income, now. Try these two questions to see if you're following with an overview of comprehensive income out of the way, let's turn to the statement of cash flows. The cash flow statement tells us the story of how the company's cash position changed from the beginning of the period through the end of the period. But as a first step to our discussion, let's contemplate why cash is so important that a whole statement is dedicated to this one asset, why is cash so important? I thought it would be nice to get some ideas from the business owners we've met in previous lessons starting with Jed. >> The importance of cash. >> Boy, cash is very important in our business. >> Okay. >> First of all, it gives us flexibility if we need to make a purchase, sometimes the manufacturers will have close out where a model that's been very successful for us has become. There's a new version taking its place and we will be able to buy, sometimes we bought 100 to $200,000 worth of a special model. We have a warehouse that we will keep these shoes because we know that these shoes are highly popular, highly successful. And so, we'll get a huge discount on this close out model and we'll be able to offer that discount to our customers push, that also helps our margins later on. So sometimes it's nice to have cash that gives us flexibility to make those purchases but generally speaking cash is just a great thing to have. And it's much better to have on our balance sheet to have cash than it is to have receivables from our customers or inventory because both receivables and inventory. There's a risk that inventory will gradually be devalued over time, receivables from our customers, some of the uncollectible. So cash on the balance sheet is much more valuable to us than the risk of having those other items. >> Right. >> So you guys pay attention to cash? >> I probably look at my bank account twice a day, in the morning and at night, I mean, it's the only. >> It's still there. >> It is still there, well and just checking that the credit card sales are going in and so much is done electronically, now, all of the taxes are coming out electronically. So just seeing when those hit because it's like, okay, so you have two payrolls which are kind of your big expenditures. You have rent, you have all of your state taxes and your employment taxes. And you kind of want to spread those out throughout the month rather than having them all on the 15th or whatever because you're kind of working off the cash coming in every day. >> So cash is important for a number of reasons, let's now look at how the cash flow statement helps us understand how the company is managing its cash to begin. You should know that the term cash flow refers to cash leaving the company or arriving into the company as a result of transactions or events. Now, let's get familiar with what the statement looks like, you'll notice that the cash flow statement is separated into three sections, with each section specifying a particular source or use of cash. The first section captures cash that was generated or used as part of operating activities. The second section presents cash that was generated or used during the course of investing activities. The third section depicts cash that was generated or used as part of financing activities. I want to discuss each of these three sections in a bit more detail, beginning with the cash flows from operating activities. As we take another look at this section, you might notice that something looks a little strange. You see that income at the top of the section list of items and then a summation that results in cash flows from operating activities. This presentation is unique to the operating activity section and it's called the indirect approach to presenting cash flows. What you see is a sort of reconciliation of net income to cash flows from operating activities where the company begins with net income. And makes adjustments to net income to yield cash flows from operating activities, what are some of these adjustments? Well, let's think about it first, not everything that affects net income also affects cash, so if we want to adjust net income to better reflect cash flows from operating activities. We need to adjust net income for transactions or events that impacted net income but does not impact cash, a common example would be depreciation expense. Remember that, so we need to adjust net income for depreciation expense, second, there may be transactions or events that affect that income in cash but aren't tied to normal operating activities. For example, if Missy sells her monster mixer to someone who pays her cash, net income and cash are impacted. But Missy's normal operating activities don't include selling mixers, so we'll need to make another adjustment to net income. Finally, there can be a difference in timing between when operating transactions, increased revenues or expenses on the income statement. And when the company receives or disperses disperses cash for these same transactions and taking another look at the cash flows from operating activity section. You see net income and then you see these three types of adjustments, adjustments for items that affect that income. But don't affect cash, such as depreciation expense, adjustments for items that affect that income in cash but aren't related to operating activities like this gain on equity. Investment transactions and adjustments for timing differences between transactions effect on net income and their effect on cash captured by adjustments for changes in assets and liabilities. The remaining two sections of the statement of cash flows use a more direct approach to capturing cash activity. Cash flows from investing activities relate to the impact of transactions associated with the company's long term assets, here, you see descriptions of cash inflows or outflows. Typical cash outflows from investing activities involved transactions where the company paid cash for land or equipment or for the stock of another company. Typical cash inflows involved transactions where the company sold land equipment or stock in another company and received cash in return. Cash flows from financing activities relate to the impact of transactions associated with the company's long term liabilities or its equity. Typical cash outflows from financing activities involved the company using cash to pay off alone, such as the retirement of long term debt. Typical cash inflows from financing activities involve a company selling its own stock for cash or receiving a cash loan from a lender denoted here as proceeds from a long term debt. At the bottom of the cash flow statement, we see the sum of cash inflows and outflows across the three sections. This sum is then added to the company's beginning cash balance from its balance sheet. To confirm that the changes to cash documented in the cash flow statement explain the change in cash from the beginning of the period to the end of the period. Before we wrap up our conversation about statement of cash flows, let's make sure we understand why this statement is important. Let's say you're looking at Jed's cash flow statement, remember how important cash is to Jed. If you see Jed has doubled his cash balance from the beginning of the period to the end of the period, would you say that's a good thing? Of course, unless the catch jet generated comes from the selling of his display shelves in obtaining a bank loan yet, you may not have noticed where the cash came from. If not for the statement of cash flows, next time we get together, we're going to set a different path. We've already covered the primary financial statements, but there remains an important element of the financial statements that often can go unnoticed. We can't overlook the notes to the financial statements, don't worry, we won't, but until next time, be well.