Well, we're here. It's finally time to talk about statement of cash flows. Now, I know for a lot of you, I keep talking about accrual accounting and how useful it is, but in the back of your head you keep thinking, no really it's cash that I want to know about. Finally, I'm going to give in to that, and I'm going to talk to you about the statement of cash flows. Of course, before I do that, I want to take one last shot at convincing you that the accounting statements are really where we're going to get most of the useful information. So, let me remind you about those accounting statements. Remember that balance sheet, it answers that question of where do we stand today. It gives us a picture of what we have, what we owe, and what's left over for the owners. In order to give a good idea of where we're really at, we're going to make some economic estimates of what's going on. Then, we have the income statement that's going to answer that second question, what happened over this period, or how much value did we create during this period? It gives us details of the value generated by firm operations, and all the related costs that we had to use up to generate that. To help us understand the business model and the actions of the firm during this period. It's also based on economic estimates. Now, the fact that we use these economic estimates is the reason that we call these accrual accounting statements rather than just accounting statements. So, what is this accrual accounting? I've told you about it before, but let me remind you because we haven't talked about it recently. Accrual accounting is the accounting method that records revenues and expenses in the period when they are incurred, regardless of when cash is exchanged. What we're trying to do is figure out economically what's really happened in the firm to communicate that to people. So, we're trying to get at this goal that accounting is equal to the economics of what's really occurring. I wish I could tell you, we always get that perfectly. But all economics and all forecasts about the future also has measurement error. So, anytime that we give you an accounting number, we're giving you economics plus measurement error. That would be okay, except the minute there's measurement error, there's room for people's biases to come into play as well. So, when you get an accounting number, you're getting economics plus measurement error plus bias. Now, on the one hand, that makes a lot of people uncomfortable, and they say they'd rather have something else. On the other hand, if you think about what we're trying to capture here, it's the relevant information that you really care about and trying to understand a firm. Okay. Enough about accrual accounting. Let's talk about cashflow like I promised I would. Let's start with why does cash get it's own statement? Well, for one thing, cash does provide an alternative view of the economic activities of the firm. It gives us another way to think about what's going on, and to the extent that you're really worried about that measurement error and bias, cash gives us this alternative view that we may be able to use to help understand the measurement error and bias. So that both the cash view and the accrual accounting view are more useful to us. Now, another issue is that, economic value creation is really important. But remember that economic value creation looks into the future, and tries to use economics to pull back the impact of expected transactions. That's what we really want to know if we want to understand the long-run potential of the firm. But remember cash illiquidity may make it impossible for the firm to survive to experience that long-run. So, cash is special relative to a lot of other accounts, because we need to have cash liquidity in order to keep the firm operating, to get to that economic value creation we think we're going to eventually achieve. One way I tell students to think about this is, it's like the blood in your body. Now, if you have healthy organs everywhere, but for some reason you get a cut and all of the blood runs out of your body, your body can't continue to exist even though all of those great organs made it seem like the long run was going to look good for you, that lack of blood, the blood illiquidity resulted in not being able to survive to that long run good outcome. Of course, on the flip side, you might have great blood just like you might have great cash, but if all of your organs are in trouble, then you're still not going to survive there either. If I really want to understand your health, I have to understand a lot more about your body, then just tell how much blood is in your body. You can think of cash the same way. Now, there's one other reason that we give cash its own statement. If people were going to steal from a company or misuse assets from a company in some way, it almost always impacts cash. I mean, think about it. I'm not suggesting that you steal from a company. But if you were going to, think of our library of knowledge, our old bookstore example. Would you want to steal a bunch of books, and then have to take those books and sell them to somebody else, probably at a big discount, there'll be a lot of hassle there, it'd be a lot more work, and it's probably not the most value added way to steal. When people steal, they usually go for cash. Sometimes it's not outright stealing, rather it's abusing things in the firm. Buy themselves a plane tickets in first-class so that they can enjoy that at the expense of that company. Again, cash will often highlight these sorts of activities. So, we have a cash flow statement partially to be able to track these sorts of decisions, and make sure that this highly liquid and desirable asset to be pilfered, is in fact not pilfered. So, those are the three main reasons we have cash flow statements. In the next couple of videos, I'll show you how cash flow statements work and how to understand them.
