Accounting Change

Finance allah shmoop what is cash flow versus earnings Okay

you think profits or profits right Well not unless you

spell it P r o p h e t s

Ask a gandhi or jeff bezos about that All right

Well in the land of accounting there are aptly named

accounting profits and there are also cash profits and the

two of them are often very different Accounting laws skew

things when it comes to assessing riel cash profits Here's

out the ceo and founder of give a dog a

drone A company that specializes in engineering remote control toys

for your pets built a drone stamping factory for one

hundred million dollars knowing that it will be worth twenty

million dollars in scrap value in just four years Well

he'll sell at that point and possibly upgrade if demand

for puppy and kitty tech is still high will drone

sales or steady producing cash profits of fifty million bucks

a year each year into the foreseeable future but stated

earnings and cash flows here are very different In the

first year when the factory was built the company lost

big cash money because it had to write one hundred

Million dollar check to the builder of the factory Yes

it made fifty million in profits but that year it

lost fifty million dollars in cash Luckily it had no

debt and it had one hundred twenty five million dollars

in the bank Well that bank account went down to

just twenty five million when they wrote one hundred million

dollar check But it gradually filled back up to seventy

five million by the time that year was done fifty

million of profits and that fifty million in cash Yeah

that that helps that floated right back in there Okay

so the cash that year was volatile It was a

hundred twenty five million to start But then i went

down to twenty five million after the factory purchase than

end up a year later with fifty million added to

their coffers and gas profits from operation leaving them with

seventy five million bucks in the bank got all that

All right So here's where the difference hits between accounting

profits perspective and a cash flow perspective on the notion

of profit Simply put it isn't fair for the company

Tohave a view that the one hundred million dollars factory

as an expense should all hit the profits line all

in one year as if they bore the burden of

all that factory cost in one year and then showing

it is being worthless in years Two three four and

maybe beyond In fact the company doing proper accounting depreciates

that factory in value to the tune of twenty million

dollars a year for for four years until it will

then sell it for scrap for twenty million bucks So

that hit to the company in the first year should

be twenty million dollars in value not one hundred million

in cash That's an accounting change of assessing twenty million

in expenses not one hundred million how's that work well

the decline in value of that hundred million dollars takes

five years And it looks like this But in your

won the company loses one hundred million dollars in cash

but gains a factory Confused Good Okay well let's zoom

forward to your floor The company again made fifty million

dollars in cash profits but it will show earnings of

only thirty million Why Well because proper accounting using straight

lined appreciation of that hundred million dollar factory properly shows

the company depreciating it's value another twenty million dollars against

its cash profitability So what A thirty percent tax rate

company pays taxes on thirty million of profits or a

tax bill of nine million bucks It's accounting earnings are

actually twenty one million dollars but it will have produced

cash or cash flow of fifty million dollars minus the

nine million in taxes or forty one million in cash

profits I either Cash flow is almost double the reported

accounting profits Now with all that profit our company can

finally start mass producing kitty copters Yeah yeah we're naming 00:03:55.308 --> [endTime] this cat todd