hello I'm Professor Brian B and welcome back in this video we're going to take a look at what the financial statements can tell us about a business to do so we're going to look at a very simple business with just a few transactions to see how those transactions would affect the required financial statements I'm going to throw a lot of Concepts at you in this video but it's meant to be an overview we're going to go through all these Concepts again later on in the course let's get started the example we're going to look at
is Dave's Car transport service so Dave starts a business to transport expensive cars on December 1st 2015 he receives $50,000 cash from issuing common stock he also borrows $80,000 from a bank and will buy a $100,000 truck the truck will be used for 48 months with a $4,000 salvage value excuse me Professor what the lamb is Salvage Val you uh just hold on a little bit we'll get to that a little later they've also pays $112,000 cash up front to rent office space for the next year during the month of December Dave's company moves two
cars the clients will pay them $40,000 within 30 days Dave also pays his employees $110,000 of wages now it's December 31st and the bank wants to see some financial statements the bank wants to see financial statements because they want an answer to the question did the company make money during December now there's a number of different ways that we could try to answer this question the first way would be to just look at all the cash flows so if we take the facts and look at the cash flows uh DA's company received $50,000 cash issuing
stock borrowed $80,000 from the bank and bought $100,000 worth of truck they paid $122,000 cash up front to rent office space for a year they paid wages of $10,000 during December and they did not collect any cash from customers during the month so if we add it all up they had a net cash inflow of $8,000 but as it turns out this is a really bad way to figure out whether the company made money or not for December pardon me what is wrong with that anytime I end the month with cash in the bank it
is a great month well this is how a teenager would do accounting you get an allowance from your parents you borrow some money from your parents you spend a bunch of money if you end the month with money in the bank was a pretty good month but this doesn't work so well for companies all the company would have to do to post better performance under the system would be to borrow more money or sell more stock a better way to look at cash flows would be to separate them into whether they come from operating the
business or investing for the future or financing for the long term let's try organizing the cash flows by The Source or use of the cash so let's start with with cash flows from operating the business this would be cash that was paid for the rent the cash that was paid for the wages we didn't actually collect anything from customers so the net cash flow from operating the business was a cash outflow of $22,000 then we could look at Cash required to invest in the business for the long term so the company spent $100,000 cash to
buy a truck which resulted in a total cash outflow from invest activities of 100,000 and then finally we can look at Cash used to finance the business so the company received 50,000 in cash issuing common stock they borrowed $80,000 from a bank which was a net cash inflow from financing activities of $130,000 we still get the same bottom line of $88,000 but now we've organized the cash flows based on whether we're operating the business investing in the business or financing the business and this is exactly what the statement of cash flows will look like it's
going to report the cash transactions for the company over a period of time like the month of December split up into operating activities which are transactions related to providing goods or services or other normal business activities investing activities which are transactions related to the acquisition or disposal of long-lived assets and financing activities which are transactions related to owners or creditors another way to try to answer the question of whether the company made money in December is to look at accounting income accounting income tries to look at business activities rather than cash going in or out
for example we actually did move two cars during December even though we haven't got paid cash yet we're likely to get paid cash so why not book revenue of $40,000 to recognize the cash that we'll eventually get from providing the service of moving the cars even though we paid $100,000 for a truck we're going to use that truck over years so why not allocate the cost of the truck over the four years so we have a $100,000 truck with a $4,000 salvage value Savage value is how much we think the truck will be worth when
we're done with it so let's take that $96,000 of value that we're going to use up divide it by 48 months and recognize a $2,000 expense of using the truck each of the next 48 months we paid $122,000 cash up front to rent office space for year but we've only been in there for one month so why not just show one month of expense $1,000 rather than the full $112,000 of cash that we paid up front we paid $110,000 of cash to employees for wages that was all due to work they provided this month so
we'll show that all as a wages expense that gives us something called net income net income is a measure of whether we priced our service moving cars high enough to cover all of the cost or expens of running the business all the cost of moving the cars and this is what the income statement is going to tell us it's going to give us the results of operations over a period of time using this notion of a cruel accounting where recognition is tied to business activities not to cash flows we'll have revenues which are increases in
owner's equity from providing goods or services and we'll talk more about what owner's equity is in a little bit we'll have expenses which are decreases in owner's equity which are incurred in the proc process of generating these revenues it's the cost of doing business the bottom line or the difference between revenues and expenses is going to be called net income which is also called earnings or net profit and it's important to note that it does not equal the change in cash because it's giving you a measure based on business activities not purely cash flow this
does not make any sense how can we record Revenue without getting any cash what is this depreciation stuff we didn't spend 2,00 on a truck we spend $100,000 okay just give me a few videos it it'll take a little bit to explain all this to you just hang in there fine so there are two different statements for this month's results which one is better which should we use I once heard that cash is King I am going to only use the cash flow statement no no no no no we'll talk about this more but you
definitely want to use both statements because they tell you different things let's take a look at how these two statements provide different pictures of what happened with the company so starting with Revenue that tells you that you moved cars During the period and you're eventually going to get paid $40,000 from customers whereas the zero in the cash flow statement says that you actually didn't get any cash this period for the truck the cash flow statement tells you that you spend $100,000 cash on a truck the accounting income says that the cost of the truck used
up this period to generate revenue is only 2,000 because we're spreading it over the whole time that we're going to use the truck for rent our cash flow statement said we paid 12,000 cash this period for rent but our accounting income says that we only used up one month of that we still have 11,000 that we haven't used up that will use up over the next 11 months sometimes the expenses and the cash flow are the same as in the case of wages here but as you can see from the cash mop operations and that
income you're getting very different pictures cash flow from operations of - 22,000 says that you spent more cash than you had come in based on these operating activities the net income though says that you priced your service high enough to cover all the cost of providing the service which even though didn't get you cash this period should lead to positive cash flow in the future the next statement that we're going to preview is the balance sheet which provides the financial position of Dave's Car Transport company at the end of the month by financial position we
mean all the resources and obligations so the resources are what we call assets so what are the assets or resources of to DA's company well they have $88,000 of cash in the bank at December 31 2015 they have something called an accounts receivable of 40,000 that's the cash owed by customers on December 31st and that's an asset because it's going to eventually turn into cash when you collect from the customers another asset is prepaid rent remember that Dave paid 12,000 for years of rent one month has been used up but they still have 11 months
of prepaid rent this is an asset because they can occupy the space for another 11 months without paying any additional cash and then of course there's the truck which is an asset of $98,000 that's the original cost of it $100,000 minus that 2,000 that we depreciated we'll talk more about this later on so it gives us total assets or res resources of 157,000 now we can look at all the obligations or claims on these resources which are the liabilities and stockholders Equity Dave owes the bank $80,000 at December 31 2015 that's a liability called Bank
debt there's $50,000 of stockholders investment as of December 31 this is a stockholders Equity called common stock and then there are retained earnings of 27,000 retained earnings represent present all of the net income or accounting income that's been created over the life of the company minus any dividends that have been paid out which we'll talk about later and when we add it all up the obligations are the same as the resources of 157,000 and this is characteristic of the balance sheet which always has to balance hence the name I am truly lost when is this
video going to end I'm sorry I know I've thrown a lot of new Concepts at you in this video but don't worry we're going to go over everything again in more detail so just hang in there and there's only a couple more slides and we're done so as I was saying this financial statement is called the balance sheet it's going to report the financial position of the company its resources and obligations on a specific date we've got assets which are resources owned by the business that are expected to provide future economic benefits liabilities are claims
on those assets by creditors or non-owners that represent an obligation to make future payment of cash goods or services stockholders Equity or owners Equity are claims on the assets by the owners of the business those come from two sources contributed Capital which arise when you sell shares and retained earnings which arise when you operate the business we're going to talk about these a lot more in the next few videos the last statement is the statement of stockholders equity and we're going to get to this later hopefully that gave you a good overview of what the
financial statements are trying to tell us we are now going to start looking at the financial statements in more detail starting in the next video with the balance sheet and the balance sheet equation I'll see you then see you next video
