hey it's Patti Scharf CPA and co-founder of catching clouds the leader in
e-commerce accounting and today we're going to go through part four of our
series on understanding financial statements today we're going to talk
about the statement of cash flows using the indirect method the indirect method
is a lot more common than the direct method QuickBooks Online uses the
indirect method Xero uses the direct method but the reason why the indirect
method is much more popular is because the direct method means you have to
attach a second supplementary statement to kind of reconcile between your other
financial statements whereas the indirect method includes it as part of
the process so I'm going to talk about the indirect method today and let's just
go through an example because I think it helps seeing it kind of on paper so so
using the indirect method you start with your net income from your income
statement that net income amount includes activities it includes income
and expenses that may or may not have touched cash or it may or may not have
included everything that needs to be included so the indirect method has some
adjustments to get you to your actual cash flow the the income statement
doesn't do that naturally it you really need to do the statement of cash flows
so that you can make sure that you understand everything that's going in
and out and touching your checking account okay so you start with your net
income number in this case $115,000 and we're gonna make adjustments for any
operating activities so operating activities are things that are normal
part of operations business as usual it's you're collecting money from your
customers you're spending money paying your suppliers you're doing your
depreciating your assets in the normal course of business okay
depreciation and amortization by definition are and are non-cash
activities it doesn't have anything to do with cash it's just an accounting
function so that will always get adjusted out I think one of the most
common examples of an adjustment in operating expenses
is accounts receivable so like if your accounts receivable goes down it means
that your customers paid you and it doesn't matter whether the sales were
recorded this year last year or whenever they paid you so if they paid you your
cash should go up because it's not related to the sales necessarily that's
in your profit and loss statement okay same thing when your accounts payable
goes down it's because you paid bills so from one period to the next
if you're looking at your balance sheet from last year compared to this year if
you see that your accounts payable goes down extra cash went out the door if you
see your accounts receivable went down more cash came in the door so if you
take a look at this example there is net cash provided by these operating
activities of twenty thousand dollars so this is going to be adjustment to the
original amount that we've got okay the next section is for investing activities
investing activities most commonly these are things like buying computers or
assets to use in your business some kind of equipment investment or something
like that or if you sell those assets that and you get money for selling those
assets that would be an adjustment to your cash so in this case we've
purchased an extra five thousand dollars of fixed assets so cash went down that
that cash outlay went to purchase those assets it was a balance sheet activity
it wasn't an income statement activity okay so same thing with the financing
activities financing activities relate to things like loans loans from
shareholders loans from the bank loans to other entities or something like that
so in this case we have notes we we had a loan that we paid down by $50,000 so
because that loan went down that cash went out that that payment of the loan
because the loan is on your balance she is not going to be included in your
net income number of 115,000 so we have to account for that cash elsewhere
same thing with dividends dividends it's an item on your balance sheet it's not
going to be in your income and expense profit and loss statement so that
$100,000 of cash needs to be accounted for here so at the end of the day you've
got your net income that came from your profit and loss statement and then you
have these adjustments accounting for activities that don't relate
specifically to the items that are on your profit and loss statement and at
the end of the day you've got $20,000 Crees $20,000 decrease in cash if you
take that away from the amount of cash you had at the beginning of the period
you should have $100,000 at the end and when you look at your balance sheet it
does so that's how you know that you did it right so hopefully this was helpful
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