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Accounting Allah shmoop the guts of cash flow Hen Yeah

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Warning some of the material in this video will be

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offensive for mature audiences on Lee So put away your

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working cushions and hand buzzers OK get out your scalp

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Fels We're going in Cash low really comprises three elements

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You start with cash from operations Basically that's just starting

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with net income and adding back depreciation amortization and more

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on that later Ash you make from operating company After

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cash from ops you calculate cash generated or sucked away

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from investing activities Like if you bought a new tractor

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smelting plant You spent cash If you sold forty thousand

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acres you realized you didn't need any more because you're

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outsourcing your plutonium dumping to China Well then you generated

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cash And finally your third section is cash flows from

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financing activities So if you bought back your own stock

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well then you consumed cash from that financing activity If

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you sold shares to the public in AIPO or a

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secondary offering you generated cash from that financing activity Right

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You ran the Xerox machine printed a whole bunch of

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shares sold him to the public and took in cash

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Okay so those are the big three and big idea

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here Cash flow statements comprise three parts of analysis of

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cash flow Right That's the cash from operations That cash

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from investing in the cash from financing Right Tattoo that

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somewhere somewhere G rated Okay more curveballs Profits can be

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calculated or assessed through a few lenses All right let's

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look at a cruel basis Profits versus cashflow basis Profits

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Well normal income statement earnings are reported on a cruel

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basis That is they include placeholders for the decline in

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value of that tractor smelting company losing twelve million dollars

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in value a year Something like that that you'll someday

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have to replace Depreciation Remember all that Yeah well good

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because we'll throw an example at you So the two

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hundred forty million dollar tractor smelting factory reducing the value

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of that factory by two Twelve million a year or

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depreciating it for twenty years on your books is a

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non cash charge each year right Catch one out That

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first year when you paid two hundred forty million dollars

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and all the rest was just crewing for its loss

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in value Right at Cruel That is you had massively

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awful cash flow dynamics that first year when you paid

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all that money for the factory And yes in real

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life it'd take years to build something that big You'd

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make progress payments of CAF in part Along the way

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you'd have interest and probably the seller A vendor of

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the smelting plant would themselves loan you the money to

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build the factory the way GM loans most of the

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buyers of its cars money to do so But the

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key idea here is that tons of cash went out

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in Year one But then for the next day decade

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plus while there are on ly maintenance expenses on that

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factory relatively very small and minor versus building it in

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the first place So the cash flow does not change

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even though the accounting for profits does as you continue

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to depreciate the value that factory right So the notations

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of loss of profits a twelve million bucks each year

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is kind of phantom All of this assessment of cash

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outlays in the form of depreciation is phantom Until you

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I have to go pay cash to build a new

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factory Then it's not so phantom Yeah but the world

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changes fast especially in the land of technology And a

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lot of things that accountants thought would die in five

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years which cost five million dollars to start could be

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replaced with bigger better faster and stronger things five years

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after they were purchased for a tenth of the price

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at which they were being advertised away Like that million

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dollar computer now basically has the same computing power is

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an iPhone So paying attention to the actual thing that's

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being advertised or depreciated is key here Note that you

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act crew at your own peril if you act crew

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to aggressively or to pay passively when you'd appreciate that

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tractor factory well depreciating too fast leaves you with uneven

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books and then likely huge taxable profits down the lines

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almost like a tax liability In a way depreciating too

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slowly leaves you with almost falsified profits up front making

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your company looked too profitable or more profitable than it

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really wass And this violates Code one of the force

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or you know gap which is to always be conservative

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when there's a way to be conservative in presenting your

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numbers Okay so let's think about this concept another way

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An employee who makes eighty grand a year earns a

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twenty thousand dollar bonus if she exceeds a million bucks

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in sales in her territory The bonus is payable in

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April of the following year It's an all or nothing

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deal Either she gets twenty grand or she doesn't know

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middle ground So how do you account for this in

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the second quarter of the year Well a bit of

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thinking aloud here is needed And what are the odds

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She hits that twenty thousand dollar bonus figure We can't

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really be sure especially because most of our sales happened

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between Thanksgiving in New Year's And there's not a huge

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demand for ugly Christmas sweaters in April Well would it

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be the most conservative route IAEA in keeping with Gap

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to just assume she would hit her twenty thousand dollars

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bonus and then say Take a reserve for it of

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five thousand dollars each quarter That legal Is it smart

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Well sure easy to dio And then if she doesn't

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turn her bonus well the five grand times four Corridors

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just gets unreserved and becomes accounting profit in the first

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quarter of the following year Once again this is accrual

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accounting because we act crew over the year the amount

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of bonus that may or may not be paid out

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And we do it in a conservative manner so that

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any surprises air positive at least from an accounting perspective

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and note loudly that we are rooting to pay her

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the bonus We want sales toe happen If she doesn't

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get her bonus it'll be a sad day all the

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way around what lots of things get accrued for in

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accounting land One form of cruel is eight Sinking fund

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We've touched on this concept lightly in the form of

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a ten million dollar factory we know we'll need to

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replace in ten years So rather than suddenly having a

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surprise of that factory of vanishing what we create a

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separate bank account toe hold cash which is sunk into

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that account and say the rate of a million dollars

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a year so that after ten years we have ten

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million dollars sitting in our little Wells Fargo bank account

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ready to go buy us a brand spanking new factory

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So that's a cruel accounting What's cash account Well basically

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the opposite In other words we could just follow the

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cash way simpler In the case of the employees twenty

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thousand dollar bonus We could pretty much ignore everything until

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we wire out cash when that bonuses paid And note

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that the employees earned that bonus from Jan One to

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December thirty one of the given year Then a stub

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quarter went by from Jan One until the next year

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March thirty one there And then in April the bonuses

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paid in cash So we just followed that date That

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cash was paid well Cash accounting simplifies things dramatically because

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all you have to worry about more or less is

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the cash sent out of the till The downside is

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that when you have shocks to the system like the

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sudden payout of cash on bonus day well the company

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appears to be financially more volatile than it really is

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Most larger companies actually keep both sets of numbers which

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served to double check and more less spy on each

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other keeping both sets of things thinking's accurate and logical

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So those air the raw uncooked guts of cash low

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two flavors that cruel and cash and you really have

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to know both So fingers crossed the anesthesia doesn't wear

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off anytime soon because these guts look like we really 00:07:09.535 --> [endTime] messed with him

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