Accounting Basics - Cash Flow Cycles

Welcome, everybody, to Module two foundations, section three cash flow cycles. The first two sessions of this module, we went over the core foundation items, then we went over the actual financial statements themselves. Now we’re going to go over the cash flow cycles. We’re going to go over the two main cash flow cycles that truly are going to affect your business. But I wanted to put this particular item here in this module on the foundation module so that you can see first what are the cycles and then how do they affect them statements. So what we’re going to do is if you still have that core financial statement templates available, please have that I’m ready for when we do this particular session because we’re going to go back into it and we’re going to drop some entries in so that you can see how the cycle affects the actual statements themselves. So let’s go ahead and begin. We’re going to cover the cash receipts and the cash disbursement cycle. Now, I know that seems kind of simplistic, but we do need to at least walk through and expose you to the cycle so you understand how those particular cycles work on the cash flow cycle. The cash receipts cycle is your income cycle. That is when you have a sale and then you send out the invoice. If it’s going to be on credit or you collect the cash, then you record the information into the system, then you deposit into the bank and then you do a bank reconciliation and then you’re back to a sale cycle again.

Same thing with cash disbursement. It’s going to be when you incur an expense, you pay for it or you record as an AP. If you buy on credit, make sure that it’s booked into the account, write a check for it, reconcile your bank account back to doing the expenses again. So you’ll also hear these called as the income cycle and expense cycle. They really mean one and the same. And that’s why I put these particular brackets in here on that.

So cash receipt cycle, like I says, it truly is a cycle.

And that’s why I have this little graphic here. You can get an idea is it really is it comes full circle, every single transaction. The very first part on the cash receipt cycle is sale. You either sell it for cash or you have it for credit. Somebody buys it and they are going to pay you in 30 days or 15 days and what have you. Then you record the invoice into revenue and accounts receivable. In this case, in this particular situation, I said it was AR, but you could theoretically have it hit cash as well. You would just technically skip this next step here. But in this situation, we have it hit accounts receivable. You have a credit, so you have the transaction you’re going to debit your accounts receivable for, let’s say, 100 bucks, and then you hit your revenue for one hundred dollars. So those debit and credit need to balance. Then we get to the next item, your cash collection item, and this is where somebody decides to finally pay you. And by decides, you know, it’s all technically their decision, but you get payment on the accounts receivable and so you collect the cash and you record the transaction in the system. Then you get the deposit ready to go to the bank. You put the bank deposit together. In this case, they say cash, but more or less is going to be a check and or maybe a credit card transaction.

But you get the deposit ready to be deposited into the bank, then you do a bank reconciliation. Now we’re going to do an actual separate session in module three, where we go over the internal controls on the cash cycle and pretty much all the internal controls related to the cash aspect of your business. It is an important step in this cycle, is you’re going to be depositing the money, will probably not you your staff is going to be depositing the money in the bank. And then you need to make sure the bank reconciliation is done and reviewed and monitored. And in session one of module three will go over how to review a bank reconciliation. And then we get right back to the end of that. And then we have the next cycle, the next transaction. So we go through this process again and again, and it just keeps going on and on and on. And so that’s how that flows through. And like I said, when you hear cycle and want you to think of this graph now, if you don’t sell it, you know, for accounts receivable, your circle is going to be a little smaller because you won’t have this step right here.

But if you sell it for cash, it just comes here and all the way around. But it’s still going to be a cycle. Now let’s go into the cash disbursement cycle versus receipt cycle. Same thing, except for cash is going out or is being dispersed. In this situation, you request a product or service. You know, you call up the electrician to come in and fix all the wiring in your office or you’re purchasing a product to be part of your inventory that you’re going to sell whatever it is you initiate that transaction, remember, in our cash receipts. Then you receive the invoice and you either record it in accounts payable or you pay for it right away. Again, same thing with the receipt cycle. If you have credit, you’ll have an addition step, if you have cash, you’ll come over to this stuff, but you’re going to receive the invoice in this instance as we’re report on credit and record it into accounts payable and the respective expense than the AP accounts payable gets approved for payment. Somebody goes through a review, says, yes, we truly did, you know, received this product and go ahead and pay X, Y, Z material company for that amount. Then you send the check or wire to the vendor and then again back to the bank reconciliation again. The bank reconciliation is key. Now, you don’t do a separate bankers association for your disbursements back on a separate one for the cash. That’s all intertwined into one reconciliation, but it’s still an important aspect of the cycle is a bank reconciliation needs to be done. And then from there you go to the next transaction. And so this keeps going on and on for every single transaction you’re going to have this cycle. And again, I want you just to keep this in your mind as you’re thinking about transactions and how they flow through your books, because this is important for you to understand how it’s going to flow through from kind of administrative standpoint. And now what we’re going to do is we’re going to do a quick case study and we’re going to apply this information to those core statements that we just went over in the last session. So in this situation, we say ABC company purchased 100 pounds of steel to make a product for a client. They paid a thousand dollars for the product, received the invoice, then paid out the funds. So in other words, it’s a credit transaction. Then ABC sold the product that they purchased to a customer for 1500 dollars. So in other words, in this situation, they’ll have a five hundred dollar profit and the customer purchased on credit and then the customer paid the receivable 30 days after the purchase with a check.

Now let’s see how each of these transactions we’re going to go through the first one, the expense side, and I’m going to input them into those core statements so you can see how they flow through and then do the same thing with the receipt side or the revenue side. So let’s go ahead and take a look at the core statements.

Ok, here’s our core financial statements that we had worked with in the previous session, and this is what we’re going to use when we go through these particular transactions to do this case study on the cash receipts and cash disbursement cycles. First thing I’m going to do is I’m going to write off to the side certain numbers so we remember what they are before we start putting in these transactions. So total assets is currently eighty seven thousand one sixty five. I’m going to put that off to the side. It’s hard entered, it’s not linked in anything. Our total equity is currently thirty seven, five, six, five. I’m going to put that off to the side then going to come over here to our income statement. I was going to take the net income. So right now the net income is nine twenty nine thousand nine hundred. And again, all these numbers I’m putting out to the side, these are before we put in the transactions cash flow statement. The cash from operations currently thirty seven thousand three hundred and ending cash is currently thirty six thousand six six five. Now we want to do now that we have these numbers after the service members interactive statements will once we start changing, all these numbers will flow through. I want these numbers off to the side so we can see what the effect is going to be on each of these statements as we enter the transactions. First thing, if you recall, was the company ordered thousand dollars of steel and they’re going to pay for the steel. They’re going to purchase it on credit and then they’ll pay for it to the vendor at some point in time in the future.

First thing is we have a thousand dollars and we know that this is going to be something that we’re going to sell in the future. And so because of that, that means it’s going to be an inventory item. And so we ordered the respective product and the first thing we need to do is book the debit side when we know that all assets have debit balances. So we go ahead and enter in this transaction. A thousand dollars a steal the order. Now, keep in mind, I’m hard entering these into the into the statements so that you can see them flow through. Normally you would input these into, you know, the respective modules in your accounting software and would flow through in here. You wouldn’t hit the actual statements themselves. I’m just doing this so you can see how it flows through. So don’t don’t try to hard inner stuff into your actual financials. I’m just doing this so you can see how everything’s going to flow through. The first part is in there and you’ll see that the balance sheet is currently out of balance. And that’s because we did a one sided entry. Remember the scale effect your debits and credits need equal. We got to debit a thousand dollars. So that mean we come down here and because we ordered the product and we’re going to pay for it sometime in the future, that means we probably have a payable. So in this case, we hit accounts payable. Now we’ve entered the respective transaction, we ordered the product. It’s going to be inventory, so we have it in inventory and that’s as far as we’ve gotten so far.

Right now, you’ll notice our count, our total assets went up by a thousand dollars and our equity is still the same. But that’s it. That’s all that’s happened. And, of course, our total liabilities have gone up. Now we’ll see what happens to the income statement or net income is still the same. And that’s because it was a capital transaction. It was a balance sheet only when we hit the balance sheet. Nothing hit in the income statement. Then we go to our cash flow statement. If you look, we just ordered innovatory why did our cash flow operations not change? Well, the reason being is we ordered the inventory, but it was all on credit. And so we only had inventory will take AP. We didn’t have any other accounts and so we didn’t have any cash actually go out. And so even though we order a thousand dollars of inventory, our cash from operations is exactly the same, because all we did was we increased the inventory and we increased the AP. Let’s go to the second part now that we’ve gotten the product and then we’re good with it and we get the invoice and we approve the invoice to be paid and we send them a check for a thousand dollars. So now we need to write a check for a thousand dollars. And so what happens is you credit cash or reduce cash by a thousand dollars and then we’re paying a payable.

Relieving the payable to we get rid of the payable.

If you look at our total assets are back in line with what they were when we started. Why is that? Well, that’s because all we did, in essence, is when we purchased the inventory, we moved an asset out of the cash account and put it in an inventory. This is an important concept to keep in mind is and we’ll hit it more in model three is when you have inventory, that’s your cash sitting there. If you have inventory sitting in a warehouse or if you’re working out of your house and you have in your basement, that’s cash that’s sitting there, that’s not liquid anymore. Another way to think about inventory. Have you ever heard about people saying they have too much inventory on hand when we have too much inventory on hand, if you have cash tied up into that inventory? This transaction, our inventory balance changed. Go down any income statement. Again, net income didn’t change because we didn’t hit the piano for anything. However, cash flow, we like our cash from operations. It now went down previously when we recorded the accrual entry, nothing happened. But now when we actually wrote that check and sent the cash out, our cash from operations has actually decreased. And so that’s again, important. But you see how all these transactions flow through and hit the respective statements. We’re comfortable with all that. Now we have a customer that comes into our shop and they want to buy that thousand dollars and they’re going to pay us fifteen hundred dollars. Five hundred all profit, not too bad, but they’re going to pay overtime or they’re going to pay at some point in time. You know, they’re not going to pay cash right away. First thing we say is, OK, we have a sale, so let’s go ahead and it’s going to be an on receivable.

Let’s go ahead and do the first part of our entry. We’ve got fifteen hundred because we have a receivable. Now, when you have a sale, you have revenue. Let’s go ahead and sell to the revenue and there goes our sales revenue increase. So now look at our net income that’s gone up by fifteen hundred dollars by that sale transaction that happened.

We’ve got another part of this entry I’m going to do, but I want you to see this part first and then we come to our cash flow statement. Well, my cash from operations is still that negative thousand dollar difference from the previous one. Why isn’t that changed? The reason being is you sold on credit. Again, this goes back to the comment I made in the previous session, that an account can make you as profitable as you want to be. Remember, our net income before we started this was twenty nine nine. Now it’s 31 for better cash flow and change. That’s the beauty of the cash flow statement. You somebody can book a fictitious revenue and they’re usually going to hit accounts receivable and net income. Good. Can go up not a ton, but the cash from operations doesn’t change. And that’s why this number, no cash from operations is so key, gets rid of all the stuff. Here we are back to there and then our any cash has stayed the same after the purchase of the inventory because we haven’t collected on that count civil yet. That’s just the first part of this transaction. There’s another part now when we come over here and we say, OK, we had the 1500 dollar sale, but we sent the product to the client, so we don’t have it anymore. So this 1000 dollar piece of inventory, we sold it. We don’t have it anymore.

We’re going to get rid of the inventory, take that off the books because we don’t have any more. Now we’re out of balance again. What is the other side of this entry? It is going to be your cost of goods sold because it’s part of what you’re selling. So our cost of goods sold will go up by 1500 dollars. They may come down here low and behold, our net income is now. I’m sorry, this is actually a thousand dollars. So now we come down here and our net income now is five hundred dollars. And again, I figured that when I put that. But let’s let’s go back and see what happens. If I hadn’t cut that, if we do it this way, say, oh, what’s wrong with this one, we’re going to come over here about she’s still going to be out of balance. Even if you don’t catch it immediately, knowing what the balance should be, the beauty of this balance sheet is the way it’s set up. It’ll catch that. Let’s go back and say, here’s that inventory that we released. Our net income went up only by five hundred dollars. What’s the effect on the cash flow statement? The cash flow statement? Here we are. There is what we brought in the thirty seven. Three hundred. Now our cash flow is still down a thousand dollars. Why is that? I just had a sale and I released the inventory. Well, the inventory has already been paid for and it’s already been recognized, the cash flow. Now, when you have that sale that you haven’t collected yet, you’re still going to be down on your cash from operations. So now let’s go back and collect on that accounts receivable. So here is the customer just sent you the check. They said, here you go. Here’s the 1500 or so. First thing you do, you’re going to add 2500 dollars back in here. We just got a check for 1500 and we’re going to relieve that receivable because they don’t owe any more. So now our assets look at that have now changed from.

This amount is the original to this amount, which is this is that five hundred dollars the recall, we purchased the inventory for a thousand, we sold it for 1500.

There’s our profit came in in cash. Let’s go to the income statement. Here on the income statement, again, net income is up five hundred dollars because we sold the item that we paid a thousand bucks for that we sold for fifteen hundred thousand five hundred dollars. That’s a look at our cash flow statement. Now that we’ve completed both the receipt cycle and disbursement cycle transactions, look at our cash from operations. It’s gone up by five hundred dollars. That is how the receipt and disbursement cycles affect all your statements as it flows through. And that’s why it’s important to understand how that happens.

And also, like I said, in the next module, we’re going to go over the internal controls on those cycles. But I wanted you to get an idea, see how everything flows through, because the problem with a lot of the accounting software is they have you just input it one little screen, but you don’t get to see how the transactions flow through the statements. And so that’s kind of one. It’s it’s out there. The software is there to be able to make it easy for you to input. But if you don’t know what’s happening behind the scenes, it’s hard for you to to grasp all the nuances as they flow through. And again, the other thing about this is if you do have a statement of this now gives you kind of an idea as to how or where to investigate, you know, so if you’re is reconciling and you’re comfortable with your cash reconciling, then something’s off, then, you know, OK, well, cash and are probably OK, let me check these accounts. That’s how you can kind of go down. But you need to have kind of an understanding the receipts and disbursements cycles. Now, I went through quite a lot in this, so please rewind this.

If it if it seems a little unusual to you or if I lost you somewhere, go through. And these are two concepts I want you to absolutely understand, because when we build on this and we build into the ratios and we start getting to that aspect, when we get to the ratios, we’re going to start saying, OK, why is this ratio off? Why is it not consistent with prior year? Why is it not consistent with the competitors? Or all of a sudden, it’s skewed one month? Having to understand the receipts and disbursements cycles will help you be able to find that. It’ll help you keep your business afloat because you’ll be able to understand, OK, if this is off first, let me check these cycles, make sure everything got input correctly when word got released. You know, so easy way to do this is if you sold the product but you forgot to release the inventory, you could be thinking, hey, I’ve got all this great net income. In reality, you don’t because you didn’t release the product to the cost of sales. So, again, this is why we have we have to and we want to go through this.

And so the last thing I wanted to show you on this is your equity. Remember, over here and our equity beginning in equity before we started, this was thirty seven five sixty five. It is now thirty eight zero six five difference. There’s a five hundred dollars.

As we said, our equity is an aspect of the net income coming in and closing out. That’s how those two transactions have flowed through and affected the equity and also the balance sheet.  hope this helps you again. We’re building on top of this. If this seems a little foreign to you, please take a moment to rewind and go back through it, because we’re coming up on module three and we’re going to be going through quite a bit more. And in module three, we’re going to be going over the balance sheet, income statement, cash flow. But we’re going to start going through how you tie out your accounts, how you do a bank. Correct. How do you analyze your conceivable how do you analyze your inventory? We’re going to be going through all these so all these respective line items. We’re going to start analyzing these and show you how. And then we’re going to build the ratios and we’re going to go through this actual core statement again and we’re going to start building on top of this. I hope you’ve found this informative. And I look forward to seeing you again up here on module three. Thank you.