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Video transcript
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.