Hello and welcome everyone to our lesson today. Today, I will finalize my discussion about the cash flow statement by focusing on the last two sections of the cash flow statement, investing and financing activities. As you know in the first section, the operating cash flows, we mainly summarize those activities related to the income producing activities, which are represented in the income statement based on the accrual basis. In the operating section, these operating activities are converted into the cash-basis in the first portion of the statement. While in this lesson, I am going to focus on the second two, the investing and financing. In the investing activities, I actually will focus on the acquisition of long-term assets, acquisition of investments, intangible assets, and so on. In the financing section, I will actually focus on those activities that relate to the debt and the equity. Let's start with the investing activities and take a look at what we mean by investing activities. Cash flows from investing activities are both outflows and inflows of cash caused by the acquisition and disposition of assets. Included in this classification are cash payments to acquire. One, property plan and equipment and other productive assets, except inventories. Two, investments in securities, except cash equivalents and trading securities. Three, non-tradable receivables. When these assets later are liquidated, any cash receipts from their disposition also are classified as investing activities. When I invest acquisition, disposition. For instance, cash received from the sale of the assets or from the collection of a note receivable represent cash inflows from investing activities. Please realize that unlike what the labeled might imply, any investment revenue like interest, dividends, or cash return from these investments is not an investing activity. The reason is that, investment revenue is an income statement item and therefore is an operating activities. The purchase and sale of inventories are not considered investing activities. Inventories are purchased for the purpose of being sold as part of the firm's primary operations so their purchase and sale are classified, again as operating activities. Also, the purchase and sale of assets classified as cash equivalents are not reported as investing activities. In fact, these activities usually are not reported on the statement of cash flows at all. For example, when temporarily idle cash is invested in a money market fund considered to be a cash equivalent, the total of the cash and cash equivalent does not change at all. Likewise, when the cash is later withdrawn from the money market fund, the total remains still unchanged. The exception is when the cash equivalents are sold at a gain or a loss. In that case, the total of cash and cash equivalents actually increases or decreases in the process of transferring from one cash to another cash equivalent account. As a result, the change in cash would be reported as a cash flow from operating activities. Very good. Let's go to the financing activities. Information related to the cash flows from operating activities section of the statement of cash flows allow various users to know the extent of available internal financing. That's how I internally finance my operations. However, a major portion of the financing from any company's point of view is provided by external sources, meaning stockholders and creditors. Thus, cash flows from financing activities section summarizes both inflows and outflows of cash resulting from the external financing of a business. We include in this classification cash inflows from, the sale of common stock or preferred stock, and the issuance of bonds and other debt securities. Subsequent transactions related to these financing transactions, such as a buyback of a stock, if I issued the stock, I might sometimes retire the stock or buy back as a treasury stock. Also the repayment of the debt and the payment of cash dividends to the shareholders are all classified as financing activity. When I issue, when I buy back, when I borrow, when I pay back, all those are financing activities. But here's something that I wanted to say. Since the sale of common stock is a financing activity, providing a cash return, which is the dividend to the common stockholders, is also financing activity. But is there a contradiction here? At the first glance, it might appear inconsistent to classify the payment of the cash dividend to the shareholders, as a financing while actually you're classifying the payment of the interest to the creditor as an operating activities. But remember, here's the rule, cash flows from operating activities should reflect the cash effects of items that enter into the determination of the net income in the first place. Interest expense is a determinant of net income while dividend is not. Dividend, on the other hand, is a distribution of net income, not a burden on net income, and not treated as an expense. Very good. Now, we have a special attention to what we refer to as non-cash investing and financing activities. Let me explain what do I mean by those in a simple example. Let's suppose that an entity acquired a $20 million new equipment by actually issuing a long-term note payable, in one single transaction. Undertaking a significant investing activity because obviously that is buying and equipment and financing at the same time as two parts of a single transaction does not diminish the value of reporting these activities. That is why we refer to those as non-cash investing and financing activities. For that reason, transactions that do not increase or decrease cash, but which result in significant investing and financing activities must be reported in related disclosures. It's convenient to report such investing and financing activities on the same page as the statement of cash flows only if there are few such transactions. Otherwise, precisely the same information would be reported in the disclosure notes to the financial statements. Examples of non-cash transactions that would be reported in this manner are: one, acquiring an asset by incurring a debt payable to the seller. Two, acquiring use of an asset by entering into a lease agreement. Three, converting the debt into common stock or other equity securities. Four, exchanging non-cash assets or liabilities for another non-cash asset or liability. Here I wanted to point out that some non-cash transactions have special attention. Non-cash transactions that do not affect company's assets or liabilities, such as the distribution of stock dividends, are not considered investing or financing activities and obviously are not reported as such. Recall that the stock dividend merely increase the number of shares of stock. From an accounting standpoint, the stock dividend causes a dollar amount to be transferred from one part of the shareholders equity, which is retained earnings per inequity, to another part of the shareholders equity, which is the paid-in-capital. Neither assets nor liabilities are affected. Therefore, no investing or financing activities has occurred and will be reported for such stock distributions. In conclusion and to summarize this lesson, it is important to remember that regardless of which method a company chooses to report the operating activities, direct or indirect, that choice has no effect on the way it identifies and report the cash flow activities for the investing and financing sections on the cash flow statement. Notice also that major non-cash investing and financing activities will be reported either subsequent to the cash flow statement, or in the notes disclosures with the other footnotes. Thank you.
