In the last series of
examples, we go into month two with $100 in cash. And the way we set
up the example, we spend $200 in month two. And what we've been doing
so far is we're saying, oh, that gets us to a cash
balance of negative $100 at the end of month two. And that's a little unrealistic. I kept it simple
here, and I allowed us to have a negative cash
balance just for simplicity. But usually you will not
see a negative cash balance. The fact that you have
a negative cash balance and you're allowed to
operate, it essentially means that someone
is lending you money. So to make this example a
little bit more realistic, let's imagine a situation. So in month two,
you only have $100. The person that you're
catering for-- that you're buying these $200 of
supply for-- they're not going to pay you
until next month. So you tell the people that
you need to buy stuff from, look, I only have $100. I have this customer. I'm doing the catering
for them this month. Can I pay $100 to
you this month, and then maybe pay another
$100 to you next month? And let's say that
they agree to that. So in month two,
on a cash basis, instead of spending
$200, you're actually spending-- I'll
just write over it-- you're actually spending $100. And then in month three,
you'll also spend $100. Now, this will change your
cash accounting numbers. This will now be negative 100
and this would now be $500. But the more
important thing is, I want to show you how
this could be accounted for in accounts payables. The fact that you essentially
told your vendors, even though you gave
me $200 worth of stuff, I'm only going to
give you $100 now, and I'm going to give
you $100 later-- that means that you've increased
your accounts payable by $100. You've increased this
liability that you owe things to other people. So let me add accounts
payables over here. So I will add it-- I'll add
it in a row-- I'll do it on both of these diagrams-- So
I'll just call it accounts-- I'll just do A period,
so I don't have to write the whole
thing-- accounts payable. And going into the
period, you didn't have any accounts payable. And then now that
you're essentially borrowing $100
from your vendors-- you're allowing to push
back when you pay them-- You now have an accounts
payable of $100. And I'm not going
to work through it on all of this stuff over here. But let's see how that would
have affected the income statement and the
balance sheets. So over here, all
of a sudden, you had another liability--
accounts payable is a liability-- You
have an accounts payable liability of $100. So at this point, we had no
accounts payable liability. And then after the
end of the month, we have an accounts
payable liability of $100. We owe $100 to our vendors,
and our cash is now at 0. So notice it still does
not change our equity. We essentially
added $100 to cash, and then we added
a $100 liability. They cancel out. If you take now this part
right here, all of the assets are 400. 400 400 minus 100
in liabilities still gets you to 300 in equity. But now the reconciliation is to
go from $100 in cash to 0 cash. We're not allowing
ourselves to go negative. And the reason why we can
do that is we actually have a source of cash. So let me erase
that, and then let's add a line right
down-- Let me see if I can add a line
right over here. So we could say accounts
payable increase, and now this is
a source of cash. And it might not be obvious. We're increasing a liability. But it's a source
of cash because we don't have to use our own cash. By increasing the
accounts payable, it's allowing us to not
use all of our cash. So we have an accounts
payable increase of 100. So this is a source of cash. So now the cash
from operations-- 200 net income,
minus 400 plus 100. This whole thing is now minus
100 cash from operations. So you start with
$100, you use 100. Our ending cash is now
0, and it all works out.