>> Hello, I'm Professor Brian Boucher 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 g
oing 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 goin
g to look at
is Dave's Car Transport Service. So Dave starts a business to
transport expensive cars. On December 1, 2015, he receives
$50,000 cash from issuing common stock. He also borrows $80,000 from a bank. And
we'll 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 value? >> Just hold on a little bit,
we'll get to that a little later. Dave also paid $12,000 cash upfront,
to rent office space for the next year. During the month of December, Dave's com
pany moves two cars the clients
will pay them $40,000 within 30 days. Dave also pays his
employees $10,000 of wages. Now it's December 31st and the bank
wants to see some financial statements. The bank wants to see financial statemen
ts 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 of the cash flows. So, if we take the facts and look at the cash flo
ws, Dave's company
received $50,000 cash from issuing stock, borrowed $80,000 from the bank, and
bought $100,000 worth of truck. They paid $12,000 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 mon
ey from your parents. You spend a bunch of money. If you end the month with mone
y in
the bank, it was a pretty good month. But this doesn't work so
well for companies. All a company would have to do to post
better performance into 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 t
he cash flows
by the source or use of the cash. So let's start with cash flows
from operating the business. This would be cash that was paid for
the rent. The cash that it was payed for the wages. We didn't actually collect
anything from customers, so the net casual from operating the business
was a cash outflow of $22,000. Then we can look at cash required to
invest in the business for the long-term. So the company spend $100,000
cash to buy a truck, which resulted in a total cash outflow
from investing 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 from 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 $8,000. 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 fi
nancing 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 d
id
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 four 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. Salvage 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
expensive of using
the truck, each of the next 48 months. We paid $12,000 cash upfront
to rent office space for a 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 $12,000
of cash that we paid up front. We paid $10,000 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 costs or expenses of running the business,
all of the cost of moving the cars. And this is what the income
statement is going to tell us. It is going to give us the results
of operations over a period of time, using this notion of accrual accounting, wh
ere 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
owners' equity is in a little bit. We'll have expenses,
which are decreases in owners' equity, which are incurred in the process
of generating these revenues. It's the cost of doing business. The bottom line o
r the differences between
revenue 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 a measure based upon business activiti
es,
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
0 on a truck,
we spent $100,000. >> Okay, just give me a few videos. It'll, it'll take a littl
e bit
to explain all this to you. Just, hang in there. >> Fine. There are two differen
t 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 thes
e two
statements provide different pictures of what happened with the company. So star
ting with revenue, that tells you
that you moved cars during the period and you are eventually going to get
paid $40,000 from customers. Where as the $0 in the cash flow statement
says that you actually didn't get any cash this period. For the truck,
the cashless statement tells you, you spend a $100,000 cash on a truck. The acco
unting 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 cashless 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 we'll use up over the next 11 months. Sometimes th
e expenses and the cash flow
are the same as in the case of wages here. But as you can see from
the cash from operations and net income,
you're getting very different pictures. Cashflow from operations
of negative 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 pri
ced your service
high enough to cover all the costs of providing the service. Which even though i
t didn't get you
cash this period should lead to positive cash flow in the future. The next state
ment 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 m
ean all
their resources and obligations. So the resources are what we call assets,
so what are the assets or resources of Dave's company? Well they have $8,000 cas
h 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
a 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 $100,000
minus that $2,000 that we depreciated. And we'll talk more about this later on.
So that gives us total assets or
resources of $157,000. Now we can look at all the obligations or claims on these
resources which are the
liabilities and stockholder's equity. Dave owes the bank $80,000 at December 31,
2015. That's a liability called bank debt. There's $50,000 of stockholder's
investment as of December 31. This is a stockholder's
equity called common stock. And then there are retained
earnings of $27,000. Retained earnings represent
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 bal
ance
sheet which always has to balance, hence the name. >> I am truly lost. When is t
his 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. Creditors, that represent an obligation
to make future payments of cash, goods, or services. Stockholder's equity, or ow
ners' 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 g
ave
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.