Hey there I'm James you're watching Accounting Stuff and in this video we'll go over the
Cash Flow Statement for beginners a Cash Flow Statement is a financial statement
that summarizes a business's cash inflows and outflows over a period of time
we'll get into how that works in a moment but first why do we need a Cash Flow Statement?
in accounting there are two main methods for preparing your books
the cash method and the accrual method with the cash method you recognize your revenue
when cash is received and you record your expenses when cash is paid out
but under the accrual method you recognize revenue as it's earned
and record your expenses as they are incurred so what does that mean?
if you're cash accounting then technically you only have one financial statement
the Income Statement it summarizes your revenues and expenses
over a period of time leaving you with a profit or a loss
but with the cash method we said that you recognize revenue when cash is received
and you record expenses when cash is paid out that leaves you with a net cash inflow or an outflow
so the Income Statement prepared under the cash method is equivalent to a Cash Flow Statement
keep that in mind we'll come back to it later plenty of small businesses do their books this way
which is fine but the cash method isn't allowed under IFRS or GAAP if you're following either of these
then you must use the accrual method so revenue must be recognized as it's earned
and expenses must be recorded as they are incurred in accrual accounting we still have the Income Statement
but this time it represents what a business has earned and incurred not is cash inflows and outflows
so it's not equivalent to a Cash Flow Statement
so businesses using the accrual method keep a separate Cash Flow Statement alongside their
Income Statement and they also keep a Balance Sheet which holds their
assets, their liabilities and their equity not long ago i made videos covering the
Income Statement and the Balance Sheet you can find links to both of those
down in the description what is a Cash Flow Statement?
at the start i said it summarizes a business's cash inflows and outflows over a period of time
but what does it look like? we begin with the opening cash amount
at the start of the period and compare it against the closing cash amount at the end of the period
you can find both of these numbers in the Balance Sheet the movement between the two
is the net increase or decrease in cash and once we know that then we can get
onto the real purpose of the Cash Flow Statement explaining how we ended up here
there are three main sections cash flow from operating activities,
cash flow from investing activities and cash flow from financing activities
operating activities are the main revenue generating activities of the business
these are the cash flows involved in selling goods or services
investing activities sit outside of the businesses core operations
they involve the buying or selling of investments or other long-term assets and finally
financing activities relate to funding the business through raising or repaying cash
to third-party banks or the owners of the business this my friends is the basic structure
of the Cash Flow Statement positive numbers represent cash inflows and
negative numbers are cash outflows now there are a couple of ways to make
a detailed Cash Flow Statement we can use the direct method or the indirect method
we'll start with the direct method cash flow from operating activities
under the direct method mirrors the Income Statement prepared under the cash method
which we saw earlier at the top we have cash receipts from customers
which mirrors revenue and then we have the cash paid out to suppliers and employees
and then interest and taxes paid collectively these mirror the businesses expenses
cash flow from investing activities includes cash outflows from buying investments or
other long-term assets and the cash inflows that come with selling them
cash flow from financing activities relates to the raising or repaying of cash or capital
there are two ways a business can do this using liabilities or equity
they can borrow money from a third-party bank which would increase their liabilities
or a business can look to its owners its shareholders who can make capital contributions
which increase equity on the flip side they also make loan repayments back to the bank
and distribute dividends back to the owners when we add up the net cash flows from operating,
investing and financing activities we can reconcile the net increase or decrease in cash
back to the movement in the Balance Sheet
now how does the indirect method work? the only section that changes is cash flow from
operating activities we use three steps to work it out
the indirect method always begins with the net profit or loss from the Income Statement
then in step two we add back all the non-cash expenses that appear above it
these don't represent cash outflows and they need to be reversed out
the usual suspects are depreciation and amortization and any gain or loss on the sale of non-current assets
or long-term assets finally we adjust for the movement in working capital
working capital is the difference between current assets and current liabilities
increases in current assets like inventory or receivables reduce cash flow
whereas increases in current liabilities like payables increase cash flow
you can find all of these numbers on the comparative Balance Sheet
now you're probably thinking that the direct method sounds a lot easier
why don't we just use that?
you're right it is easier to read but it's actually harder for accountants to prepare
so we don't use it as much the indirect method is much much easier to work out
because we can find a lot of these numbers in the Income Statement and the Balance Sheet
as you'll see in this next example I realize that there's a lot going on here
so I've put together two cheat sheets covering the direct and the indirect Cash Flow Statement
I like to think of them as one page reference guides to help you out
if you'd like to support the channel then you're welcome to buy them on my website
the link as usual is up here and down there how do we make a Cash Flow Statement?
yes it's time for that example and we'll be using the indirect method because it's easier
we'll need a couple of things to get started
first we need an Income Statement here's one for a business called Tumble
which is a fictional dating app we actually made this one from nothing in
the Income Statement video so check that out and maybe click subscribe as well
it summarizes Tumble's revenues and expenses for the year ended December 31st
and here's Tumble's Balance Sheet which we made in the Balance Sheet video
it shows us a snapshot of their assets, liabilities and equity at the end of the year
but hold on we're using the indirect method so we actually need to see last year's Balance Sheet as well
so this is Tumble's comparative Balance Sheet we have the current year one on the left
and last year's one on the right nice, one more thing before we begin
here are some key facts which happened during the year
Tumble sold some furniture for $10,000 which originally cost them $20,000
and had been depreciated by $5,000 the loss on the sale was charged to general and admin expenses
Tumble also spent $910,000 on computer equipment they raised $100,000 in long-term debt
and made no repayments and finally they issued $50,000 in common stock
and paid out $1,000,000 in dividends right oh let's begin
what are we reconciling?
cash, this is a Cash Flow Statement after all so let's head over to Tumble's
comparative Balance Sheet we can see that they held $13,895,000 in cash
at the end of last year and this number increased to 17 million dollars
at the end of this year so we can lift these numbers and place them at the bottom
of our indirect Cash Flow Statement overall that's a net increase in cash of $3,105,000
but how did Tumble pull this off? let's find out
we'll start with cash flow from operating activities in step one we need to find Tumble's net profit
or loss for the current year that's easy we can get it from the Income Statement
on the bottom line we can see that Tumble earned $9,650,000 this year from their core operations
we'll take Tumble's net profit and put it right at the top of cash flow from operating activities
step two we need to reverse out all of the non-cash expenses
non-cash expenses appear above the bottom line in the Income Statement
some classic examples are depreciation and amortization these represent
the gradual process of writing off long-term assets they aren't cash flows
this year Tumble incurred $850,000 in non-cash expenses so we'll add this back in our cash flow from operating activities
but that's not all Tumble made loss on the sale of long-term assets
if we jump back to our key facts page we said that they sold some furniture for $10,000
so let's quickly do some workings this furniture originally cost Tumble $20,000
and by the time it was sold it had incurred $5,000 in depreciation leaving it with a carrying value
of $15,000 Tumble sold this furniture for $10,000 which left them with a loss on the sale of $5,000
this is also a non-cash expense and it was charged to general and admin expenses in the
Income Statement we need to reverse it out in our Cash Flow Statement
so we'll add back a loss on the sale of furniture of $5,000
step three we need to adjust for the movement in Tumble's working capital
working capital is the difference between current assets and current liabilities
ignoring cash current assets are typically made up of inventory and receivables
and current liabilities are payables we can find the movement in all of these
on Tumble's comparative Balance Sheet it doesn't look like Tumble has any inventory
but they do have some receivables accounts receivable, other receivables and prepaid expenses
which add up to $14,050,000 in the current year and $8,850,000 last year
that's an increase in receivables of $5.2 million during the year
an increase in receivables reduces cash flow so we subtract $5.2 million from
cash flow from operating activities I like to think of it this way
if receivables have gone up then Tumble is owed more money which isn't good for cash flow
payables work in a similar way Tumble has accounts payable, taxes payable, accrued expenses
and some deferred revenue
all of this adds up to $14.4 million in payables in the current year
and last year they had $14,850,000 in payables
that's a year-on-year decrease in payables of $450,000 we subtract decreases in payables
under cash flow from operating activities because if payables go down then more supplier accounts
have been settled so there's less cash when we take Tumble's profit
and back their non-cash expenses and adjust for the movement in working capital
then we can see that they had a net cash inflow of $4,855,000 from operating activities
a couple more things we need to do here to finish this off but first i'd like to say a big thanks
to all my channel supporters you guys motivate me to keep on making more accounting tutorials
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next up is cashflow from investing activities we're done with operating activities so the rest
of the Cash Flow Statement is the same whether you're using the direct or the indirect method
on our key facts page we can see that Tumble spent $910,000 on computer equipment
this is a cash outflow from investing activities because they bought long-term assets
but Tumble also sold a long-term asset remember that furniture we talked about?
Tumble made a loss on its sale which we called a non-cash expense
we added it back in cash flow from operating activities but we also need to record the cash receipt
on the sale of $10,000 this sale isn't part of Tumble's core business
so we record it as a cash flow from investing activities
when we total it against the purchase of computer equipment that leaves us with a
net cash flow from investing activities of $900,000 this time it's a cash outflow so the number's negative
cash flow from financing activities financing activities involve raising or repaying cash or capital
used to fund a business on the key facts page we can see that Tumble raised $100,000
in long-term debt this is a liability to a third-party bank and this year they made no debt repayments
they issued $50,000 in common stock which is a capital contribution
from the shareholders who own the business which increases equity
and they paid $1,000,000 out in dividends back to these shareholders
that would have decreased their equity we can pull all these numbers through into
cash flow from financing activities Tumble received $100,000 in cash from long-term debt
they raised another $50,000 in equity and they paid out $1,000,000 in dividends
so that's a net cash outflow from financing activities of $850,000
almost there when we total the cash flows from operating activities,
investing activities and financing activities we can see that Tumble had a net increase
in cash of $3,105,000 during the year this matches the movement in cash
that we saw in the Balance Sheet so we've reconciled this Cash Flow Statement using the indirect method
oh yeah! hope you found that helpful
let me know in the comments what you'd like to see next time bye for now