Lesson One, the importance of cash flow in a business. It's undeniable that cash is the fuel that keeps a company open. So many people get confused by the difference in profit and cash. We all tend to lean on the p&l and the balance sheet. But the cash flow statement is a report that ties everything together. This lesson will focus on cash flow and the cash flow statement.

The cash flow statement is often overlooked, it's misunderstood and usually just plant stem. But here's the important thing you need to know about this report and why you should care about it. It tells you how much cash the company generates. You want to know that your company generates cash through its regular business activities. You don't want to have to rely on external sources like debt or investors to stay in business. Here are three things you'll learn in this lesson.

Number one, you'll understand what's meant by liquidity and why cash is king to You'll be introduced to the three primary financial statements that businesses use and how they connect to cash. And then three, you understand how a cash flow statement is built, and how to interpret the results. Building a solid foundation, before you use software tools like cash flow tool will help you understand the numbers just that much better. Now's the time to pause and take a look at the supplemental materials we put into aid and guide you. These would be helpful while going through the lesson. So when you're ready, let's get started.

Let's take a little bit through this first lesson and talk about cash what it is what's cash flow and start talking about managing it. So first of all, with cash cash is really interesting, right? Because it's something that we could spend. It's not necessarily profit profit you might not have in your pocket yet. But cash is king for the reason because you have it. Now let me describe another term that's associated with cash.

That's liquidity. Now one of the things I don't like to do when I teach is talk about large terms that maybe not everyone understands. But liquidity is simply this. It's the speed that you convert your assets to cash. And I like to use the acronyms of water, slush and ice. What that means is how quickly can we convert assets to cash, cash being water, we want things to be water because it spins really fast.

So we're looking at cash, we look at cash equivalents. We look at other assets that we have, including inventory, or AR. You can convert those to cash as well. You can convert those to water, but it just takes a little bit of time takes time to collect from your customers. It takes time to sell your inventory. That's what the slush is the slush is when it takes time.

It's not cash, it's not the water, it takes a little bit of time to convert it. Now your fixed assets, your buildings, your equipment, your vehicles, I call that the ice. It's the ice because you can convert it to cash, but it may take a little bit longer than just cash in the bank. So think about that. When you think about liquidity. It's the speed that you Turn your assets into cash, we want it to be water.

Now, just a basic review of the three financial statements that we're used to. Here's the three financial statements. Look at the profit loss statement, the balance sheet, and the cash flow statement or the statement of cash flows. Profit and Loss pretty easy. We all use those, right? It's your report card at the end of the month, end of a quarter of a year.

It's going to tell you whether or not you had a good month, quarter or year, was your business viable? Did you sell more than you spent? That's basically what it's going to tell us how much profit in your business that you generate. Then the balance sheet, most of us don't understand the balance sheet and that's okay. The balance sheet is assets equals liabilities plus equity. That's the basic accounting formula.

So when we look at it, it's things that we have and things that we owe, especially what we're trying to balance out, and then the money that we put into our own company. The balance sheet is the combination of Eric Every single management decision you've ever made, everything you've done, it's there. Now the profit and loss statement gets to start over we have a bad January, we get to start over from zero on February 1. How does that happen? What happens because net profit is connected to the balance sheet, the net profit at the end of the month, end of January, we'll say, gets moved on to the balance sheet in the form of retained earnings. That's what causes the profit and loss statement to reset, go back to zero, because the profit or lack thereof that we generated, gets put onto the balance sheet in the form of retained earnings.

Now, the one we don't look at as much is that cash flow statement, the cash flow statement is simply this. It's changes in accounts period over period. How much did I have an AR last period? How much do I have this period? The changes recorded, we like to call that inflows or outflows of cash is money coming in? Where's money going out?

Bankers like to call it sources and uses Was this a source of revenue? Or was it a use of revenue. That's basically what they're using it for. So let's dig just a little bit deeper into what this means. Now I've already described the financial statements and how they connect. You can also use just the balance sheet and create a cash flow statement.

So net profit goes onto the balance sheet in the form of retained earnings. Then you take your balance sheet and create a cash flow statement. So the Statement of Cash, here's how we do it. First of all, the Statement of Cash is broken up into three different sections. It's activities that are operating activities, investing activities, and financing activities. These are ways that we use cash inside of our business.

Usually the operating activities are how we run our business. Those items are typically found on the income statement. Then we have investing activities. This is how do we use the money that's inside our company? How do we use it? Where does it go if we buy a piece of equipment, Investing activity.

If we loan money to another company that's actually an investing activity and the financing activities. The last section is how did we get money into the company to begin with? Do we take on debt financing? Do we take a loan out for the bank? Do we take on equity financing, take money out of our own accounts, or investors accounts and put it into the company's how you feed it. So that's basically the three sections the operating section, the investing section, and the financing section.

These are some typical activities that are found on where they're located, such as payments to suppliers, payments to employees, tax payments, interest payments. Those are outflows that are typically operating activities and they're found on the income statement. Then we'd have investment activities like I described, property, plant and equipment, securities collections on a principle of alone. Those are cash inflows that are investing activities, and they're typically found in the long term asset asset. Section of the balance sheet. That's right.

So you got short term assets and long term assets, they're usually found there those type of activities. Lastly is financing. When I issue debt, or I take on debt, or I sell stock to individuals, or entities, that's money that's coming into the company, for financing activities. That's how we finance a company. And you typically find these type of activities in the long term liability section or the equity section of the balance sheet. So let's talk about these type of activities.

These types of activities. Where do they come from? Here's where we're going to go through an exercise this exercise is going to show us does money come in? Or does money go out is an inflow or an outflow? If it's an inflow or an outflow, we call it a positive impact of cash or a negative impact to cash. Here's a short quiz.

I'm going to ask you, basically, a typical transaction that happens inside of a company I want to know if it's a positive or negative impact of cash, for instance, an increase in the balance of prepaid insurance, is that positive or negative? We're increasing prepaid insurance. It's actually a negative impact of cash because we use cash to actually pay for insurance. How about using some supplies that we have on hand? we decrease the amount of supplies. We were not that has a positive impact on cash because we didn't use any cash we use what we already had on hand.

How about proceeds from the sale of equipment formerly used in business? This is where we actually sold something, a piece of equipment and we got money for it. Yep, positive impact of cash because we actually sold something and brought cash into the business. But what happens if we lost on that item? If we lost money on selling that piece of equipment? Well, that's still a positive impact on cash because we still sold the item doesn't matter what we had it on the For what we sold it for, we actually brought cash into the business.

So as a positive impact. What about an increase in the current liability of taxes payable, we owe more taxes, there's an increase in liability. Probably full Jenner, it's a positive impact on cash because we might owe it, but we didn't pay it. So the cash is still in our account. So as a positive impact on cash, when I say positive here, and you talk to a banker positive also means source. They look at that as a source of cash.

How about a decrease in accounts payable, we actually paid some of our vendors. In this case, it's a negative impact on cash, because we actually took cash and paid our vendors gave it to the vendor. How about an increase in accounts receivable we sold more, so people owe us more. It's negative, and it's negative, because we actually don't have the money. people owe it to us, but we don't have it. So an increase in asset there is actually a use of cash and we haven't Increase in the current liability of warranties, right?

We've sold some stuff and we might owe on the warranty later. But it's a positive impact on cash because we aren't paying any money for it, we may owe it or we may not. It's a warranty. Now we've got dividends that are declared and paid. So we're declaring dividends. That means we're paying money's coming out of the out of the business.

So it's negative, it's a negative impact on cash. And then lastly, proceeds from the issuance of preferred stock, which means we actually sold stock to someone in the public. With With that in mind, we brought money into the business so it has a positive impact on cash. So what I wanted to do there is just kind of show you how different activities that you go through on a daily basis seems routine to you and your business. Does it have a positive or negative impact on your cash position? Remember, cash is important.

So as profit by cash is what you spend. So let's break down the operating finance And investing activities from the income statement. When we look at it here, we've got a cash flow statement section quiz, the same activities that we just talked about, where would those be placed on the cash flow statement, and the operating activity, investing activity, or financing activity. So let me read these off and show you where they go. First of all depreciation expense, where would that be found on the cash flow statement? Generally is found in the operating section, right?

Because it's actually a line item on the income statement, depreciation expense. So it's an operating activity. Then we get proceeds from the sale of equipment used in the business. We sold that piece of equipment again, where would I find the change in cash? You're going to find that in the investing activities, right? Because you're selling or buying a piece of equipment.

So you're investing in your business. What happens if we lost money on the sale of that equipment? Where would we find it? Well, it's actually going to be in the operating section because we have a lunch An item on the income statement that says loss on sale. So when we lose money on the sale, it's going to be on the income statement and captured in the net profit. Then we have declaration and payment of dividends on company stock.

That's right, we're going to declare the dividends and Pam, that's a financing activity because we're actually giving money back to our shareholders or our stockholders. What about the gain on a sale? So if we gained money by selling our automobile, or would that'd be fine? Yeah. Operating because it's the game. Remember, the gain on sale loss on sale is on the income statement.

So it's an operating activity is captured in the net profit? How about proceeds from the sale of the automobile? The money we got from selling that same car? It's investing, right? Because we invest in when we bought the piece of equipment or the automobile. So the money that comes back, it's an investing activity.

How about an increase in our inventory? To use cash and we bought more inventory, that's actually an operating activity because we need the inventory to run the business. So it's an operating activity. And then how about an increase in accounts payable? We owe more money. We bought some stuff we owe our vendors, that's going to be located also in the operating section, just saying, boy for the inventory, we actually owe people money.

So it's going to be in the operating section. How about we paid off a long term bond, right, we paid it off, we retired it. That's a financing activity, right because there's a bond that we use to finance the company. So it's going to be located in the financing section. And then lastly, we bought back some of our own stock, our treasury stock, we're using the money but it's a financing activity because our stock and it goes towards our equity. So that's a quick little quiz on where typical activities are in the actual cash flow statement.

Remember, it's Auburn activities, investing activities, and financing activities. So let's build one. Here's a typical balance sheet. It's actually taken from Old Dominion freight lines. So on their balance sheet, basically what we're looking for is the changes in accounts. In this case, you can see their accounts receivable went from 345.

To 250. It actually went down, they actually created more money, they actually brought in more money. When they collected on their accounts, they were owed 345 it went down to 250. So they increase their cash by 95 million right there. So it's 340 millions, in this case 250 million, the change in cash is 95 million. Now that same year, they bought equipment.

They used to have $2 billion worth of equipment now they have $2.2 billion worth of equipment. So that change is 260 million, they spent 260 million net of depreciation on their equipment during this year. In that case, it's a use because we increased the asset We bought more equipment, so we actually use cash to buy more equipment. So that's why you see the parentheses around 260. And that's actually use of cash, we use 260 million. So when I add up just the top section, this is the top section, the asset section, the difference in the change 95 in accounts receivable positive, negative to 60.

In plant and equipment is negative 165. So total change in our assets on the balance sheet is 165 million. If you notice there's no other changes in any of the other accounts no inventory change, no current asset change, no goodwill change, everything stayed the same. So we only looked at the ones that changed from below. If I go down to the bottom section of the balance sheet, I've got the liabilities and equity section, we're going to do the exact same thing. You've got accounts payable, you've got current liabilities, long term debt, common stock, retained earnings, there it is, again, So all of these will look at the changes.

So when they change, we're going to say is that a positive change or a negative change. And the first one's case accounts payable. We used to owe 250 million now we owe 284 million. Remember, an increase in liability has a positive impact on cash because we owe it but we still have money in the company. So that's 26 million. Now, we retired some short term debt, we paid it down from 27 million to 25 million.

So that's $2 million. We used on long or short term debt. Then we got things like deferred taxes, we used 89 million. We actually used 1 million on common stock, and then our change of retained earnings. This is where it came right off of the profit and loss statement. It went up 378 million.

So we went from 1.5 billion the year before to 1.9 million billion this year, which gives us a change of cash at 378 million. We made that much money during that year. 378 When I add those up the 26 minus the two minus a 10 minus 89 minus 14 minus a one plus a 378, I get positive 288. So think about that I've got the top section, where I've got 165, I've got the bottom section, where I have 288. The difference between the two, negative 165 to positive 288 equals 123, the actual change in cash was 123 million. And when we look at the very top, the change in cash from 12 million to 135 million, that equals 123.

So it doesn't matter how we slice and dice the numbers, it's going to come up the same, it's going to come up to the actual result of how much changing cash we experienced during that period. Okay, let's take the information we just calculated on the balance sheet and create a cash flow statement. Here's what looks like I put a worksheet inside the supplemental material so you can just download it you've actually got the balance sheet And the actual cash flow statement worksheet so you can work along with this. If you look at it, we've got everything divided, you've got the top section, rows one through 10 is the operating activities, you've got 11 through 16, on the investing activities, then we've got 17 through 23 is the financing activities. And then we calculate up what's called the free cash flow. And that's the change in cash from all three of those major sections.

And when we look at it, you'll see how this matches up exactly to the balance sheet. Here's mine already completed. So in this case, we've got net income, we transferred it right over 378. You get your 95, you're changing cash, positive 95. For accounts receivable, and if you notice, I put in a cheat sheet, you've got decrease in the parentheses increase. Here's what that means, in case you forget if it has a positive or negative impact on cash, here's your cheat sheet.

You can just look here and say, Oh, if it's a decrease accounts receivable, that's actually a positive impact in cash I collected more. Or in this case, if it's an increase in accounts receivable, I actually am still owed that money, so it's a negative impact on cash. Going down the list, we've got 26 that we put into the change in accounts payable, we've got negative 89, and income tax payable, and negative 14 on non current liabilities. Looking back at the balance sheet, you can see that actually these numbers come right from the balance sheet. all we've done is sort them into operating, investing and financing activities. So when we look at the investing activities, now, we had our equipment that we bought for 260 million, that's the negative we use that much.

So that's the only thing here so operating activities, is 396. That's the change. Then we also have the change in investing activities is 260. So we gained 396 from operating activities, but we used 260 in investing activities, Karen, that thought process along write down the financing activities. We paid off some short term debt. We paid off some long term debt.

And then we bought back some of our own stock. So that means we use 13 million in our financing activities for that period. That was the changes right from the balance sheet. When we add all three of the activities together, financing, investing and operating, we get total free cash flow, comprehensive cash flow of 123. Where have you seen that before? That's right, that's the change in cash from the balance sheet.

Doesn't matter how we slice and dice the numbers, it's going to come up exactly the same. The change in cash in the balance sheet period over period is also going to show up as the change in cash on the cash flow statement. Now let's look at what we had at the beginning of the year and what we had at the end of the year. In our case, we started from the balance sheet the year before with $12 million. Then we have 300 96 as far as operating cash flow, we use 260. for investing, we use 13 for financing, which gives us a total ending cash of 135. If you go right back to the balance sheet, guess what our cash account is worth, at the end of the year 135.

These numbers come right from the balance sheet and you can create your own cash flow statement. Now, let me focus in on that bottom section lines 25 through 29. Here's something that a lot of people don't know they don't know how to use the cash flow statement. They don't know what it means. Now if we look at those numbers that 396 and operating cash flow 260 and investing in financing is 13. It tells us is this a positive use or a negative use of cash.

In this case we got positive and operating. Negative investing, negative and financing. So it's a plus or minus minus. That creates a pattern. It tells How management is using cash in this company? Believe it or not, it's like a little hidden symbol.

It's something you can use to evaluate any company to figure out what they're doing. And how do you do that? Using this legend, this is also in your supplemental material that you can just download and use on your own company or anybody else's. So this three simple pattern, there's only eight different combinations, there's only eight ways that these can be sliced and diced. In this case, I've highlighted the plus minus minus. And if I look at the legend, what does that mean that this company is using cash flow generated from operations to buy fixed assets and pay down debt?

This is a good company, right? Because they're actually making money with their operations. And they're using it to invest in their company by buying more equipment. Now, if we look at other ones, there might be some bad ones on here as well. If you see maybe a minus minus plus. On number six, that's saying the company is growing rapidly, but it has shortfalls in cash from operations and from To purchase fixed assets, so they're actually taking on more debt, or asking for more financing.

That means, hey, I can't support my own operation. So I have to go back to the investors to bring money in. There's other bad ones on here to take a look and see where you fall. Now, I'm gonna show you one more thing to do with that pattern. Right? Typically, this also will tell you the lifecycle of a company.

Now divided them up here into wonder blunder thunder and under you might have saw this chart, and who knows how many different ways like startup to growth to mature company to a company in decline, we just call it wonder blender, thunder, and under here, with the most important one being the blender stage. This is where a company is starting to grow. But they could really make some cash mistakes, they could do a thing called grow, broke, means out run their operation. They're owed so much money, but they're still trying to fulfill orders that they run out of cash. You don't want to do that. So in this case, let's look at that three symbol pattern and try to apply it to the actual lifecycle of the company.

In this case, here's some typical patterns that you'll see from a wonder company. That's an early stage company, maybe the first 234 years, to a blender company, somewhere, they starting to make it, they're starting to get traction, people are starting to buy their products in the thunder companies, the ones that made it, that's the Facebook's and the Microsoft's of the world, or in your community, it might just be the local grocer. And then you have an under company, under companies, the ones that kind of take their foot off the gas, and they're just letting it coast. And when it happens, we typically go into decline. We don't want that to happen to you. But here's the pattern that you'll see.

Typically, from this stage of company. In our case, we had a company that was a plus or minus minus. That's typically what you see from a thunder company. They know how to make money and they know how to use it. So it's a plus minus minus or mature company. Here's your homework.

Go ahead and sign For an account, a cash flow tool comm and then see what your company looks like. So stay tuned for lesson number two. It's gonna be a good one we're gonna talk about the speed of cash.