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Prepare A Cash Flow Statement | Indirect Method - YouTube
Channel: Accounting Stuff
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in this video you'll learn how to
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prepare a cash flow statement using the
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indirect method I'll show you how this
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way is different using the direct method
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what it looks like and how to calculate
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all of the numbers using an example hey
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viewers I'm James and welcome to another
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episode of accounting staff if you're
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new here this is the channel where we
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post weekly videos teaching accounting
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basics if that's something they might
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interest you you get that subscribe
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button to avoid missing out in this
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video we're going to cover preparing a
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cash flow statement using the indirect
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method I've made a couple of videos on
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the direct method already where I
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explained the format and purpose of the
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cash flow statement and how to prepare
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it using T accounts link up here if you
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missed either of those this week we're
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going to use the same example income
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statement and balance sheet as we did
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last time but we're going to prepare it
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using the indirect method instead I
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recommend that you watch this video
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through to the end because I'm going to
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take you through all of the calculations
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step-by-step so you'll have no problem
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putting one of these together by
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yourself so without further ado let's
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get started so what's the difference
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between the direct and indirect method
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anyway the cash flow statement along
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with the income statement and the
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balance sheet make up the three major
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financial statements we use the cash
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flow statement to summarize the movement
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of the cash balance in a balance sheet
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over a period of time typically a
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quarter or a year and we do this by
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summarizing all of the cash inflows and
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outflows into three categories cash flow
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from operating activities cash flow from
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investing activities and cash flow from
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financing activities the latter two
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sessions cash flow from investing and
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financing activities are completely
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identical whether using the direct or
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indirect method the only section is
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different is cash flow from operating
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activities which is why I want to focus
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on that one in this video if you'd like
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to learn more about investing in
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financing activities I've covered them
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in more detail in the previous two
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videos that I'll drop a link to down in
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the description operating activities are
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the principle revenue generating
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activities of a business these are the
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transactions that take place on a
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regular basis under
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in the right method there are three
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steps to calculating cash flow from
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operating activities and I'll take you
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through them right now first of all we
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need the businesses net profit or loss
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which we can find in the income
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statement this method relies on starting
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off with net profit and adjusting it for
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non-cash transactions again and again
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until we're left with only net cash
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inflow or outflow most large companies
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accounts using the accrual basis which
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means their profit does not equal their
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net cash inflow under the accrual basis
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revenue is recognized when it's earned
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not when cash is received and expenses
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are recorded as they are incurred not
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when cash is paid out so revenue doesn't
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equal cash inflow and expenses don't
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equal cash outflow which brings us on to
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the second section we need to add back
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all of the non-cash expenses that exist
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in the P&L typically non-cash items
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relate to things like depreciation
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amortization or the gain or loss on
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disposal of non current assets these
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don't represent cash outflows but they
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are deducted in our income statement
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when coming to that net profit so it's
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logical that we need to add these back
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in order to remove them from our
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calculation the third and final step is
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that we need to adjust for the movement
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in working capital working capital is
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simply current assets less current
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liabilities current assets are generally
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made up of inventory and receivables
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whereas current liabilities are made up
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of payables to work out whether you need
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to add or subtract these movements in
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the calculation you need to consider the
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impact they have on the cash balance an
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increase in inventory means of business
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has less cash because it has bought more
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inventory than it is sold and on the
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flip side a decrease in inventory means
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a business has more cash because it has
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sold more inventory than it has bought
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the situation with accounts receivable
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are very similar because they are also
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assets an increase in receivables means
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less cash has been recovered from
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customers so the cash balance
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and a decrease in receivables means more
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cash has been collected so the cash
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balance goes up on the other hand
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payables are a liability so they work
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the opposite way to the inventory and
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accounts receivable an increase in
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Pebbles means more cash because less has
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been paid out to suppliers who the
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business owes money to and lower
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payables means less cash because more
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has been used to pay the bills cash
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flows from non current assets and non
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current liabilities
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tend not to be included on the cash flow
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from operating activities because
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they're normally categorized in the
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other two sections cash flows from
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investing activities and cash flows from
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financing activities now that we've
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worked out the basic calculation for
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cash flow from operating activities
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well that is practiced using this
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template with a worked example we will
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continue with that Chudley canon's
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example that I took you through in the
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previous two videos last time I showed
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you how to calculate cash flow from
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operating activities with the direct
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method and today I'm gonna show you how
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to do it using the indirect method
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instead I'm starting right now
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step one we first need to jot down the
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net profit figure because this is our
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starting point that we will make
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adjustments to in order to come to that
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net cash flow net profit can be found
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easily at the bottom of the income
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statement in this case the canons have
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made a net profit of $70,000 for the
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year so we write this down at the top of
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the calculation next we have step two
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this is where we need to add back all of
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those non-cash expenses that are shown
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in the income statement we've got to
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reverse these out of our net profit in
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order to get closer to the cash flow
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figure to do this we look over the
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income statement and search for any
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depreciation amortization or gain or
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loss on disposal of non current assets
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in this case we can only see
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depreciation of $23,000
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so we need to add back 23 into our
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calculation to adjust for depreciation
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finally in step three we need to adjust
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the movement in working capital like I
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said before working capital is made up
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of current assets less current
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liabilities let's have a look over the
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balance sheet and see what current
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assets we have I can see cash accounts
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receivable and inventory planned popteen
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equipment is a non
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and acid which affects cash flow from
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investing activities so we can ignore
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that and cash is what we're reconciling
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back to in the cash flow statement so we
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can ignore that one as well we are left
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with only inventory and accounts
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receivable a closing balance in
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inventory of 94 less the opening balance
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of 68 gives us an increase in inventory
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of 26 increases in inventory are
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represented as deductions in calculating
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cash flow from operating activities
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because the business has spent cash on
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purchasing the raw goods or by
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manufacturing them so we enter negative
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26 into our calculation now let's look
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at accounts receivable here we have a
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closing balance of a hundred and twenty
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and an opening balance of ninety eight
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which gives us an increase of twenty to
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during the course of the year increases
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in accounts receivable need to be
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deducted from our net profit in
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calculating the cash flow from operating
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activities because higher receivables
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means that less cash has been recovered
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by the business from its customers so we
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enter negative 22 into our Calchas well
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that's the movement in our current
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assets but we also need to bind the
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movement in our current liabilities so
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that we've considered all of the working
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capital reviewing the balance sheet one
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more time shows us that our current
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liabilities are made up of accounts
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payable salaries payable interest
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payable and income tax payable long term
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borrowings are suggested by their name
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our non current liabilities which relate
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to cash flow from financing activities
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so we can ignore them here where share
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capital and retained earnings relate to
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equity so these can be excluded as well
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we are left with only these four current
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liabilities the sum of their closing
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balances is a hundred and fifty six and
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the sum of their opening balances is a
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hundred and thirty one when we take the
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difference between these numbers we have
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an increase in payables of $25,000
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during the year increases in payables
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need to be added to our net profit in
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order to calculate cash flow that makes
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sense because you can imagine that if a
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business doesn't pay us invoices then it
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gets to hold on to its cash so we add
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back 25 in our workings
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boom that steps one two three completed
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all that we need to do now is take the
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total of those numbers and we're left
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with the net cash inflow from operating
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activities of $70,000 that wasn't so bad
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was it we've come to this number using
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the indirect method but a quick check of
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our calculations using the direct method
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shows that we also came to seventy
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thousand dollars cash inflow from
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operating activities we get the exact
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same answer using either technique so
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which is better
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if you've watched my other videos on the
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direct method then you'll notice that
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the indirect method is much much quicker
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which is why most large companies using
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the accrual basis of accounting tend to
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work out their cash flow this way but if
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that's case then why doesn't everyone do
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this I suppose it really comes down to
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how the workings of cash flow from
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operating activities are presented in
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the cash flow statement the layouts
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using the direct method is far more
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intuitive to read because it mirrors the
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cash basis income statement we have the
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cash receipts from customers at the top
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and below that we have the cash paid out
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to all of the various suppliers and
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stakeholders it makes easy reading for
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investors who might be glancing over the
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cash flow statement to extract
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meaningful information from it on the
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other hand the layout of cash flow from
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operating activities under the indirect
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method is far less intuitive you can
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think of the indirect method as a
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shortcut to working out cash flow from
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operating activities which is a win for
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the accountant or bookkeeper who's
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preparing it because it saves them time
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however the third parties who are
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viewing the finished cash flow statement
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lose out as this report isn't as useful
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to them like I mentioned earlier we
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skipped over cash flow from investing
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and financing activities in this video
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because these sections are identical
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under the direct method if you'd like to
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learn more about those or the cash flow
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statement
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then I recommend you check out the other
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two videos that I made that a link below
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thanks for watching we have new videos
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every Monday here on counting stuff if
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you found this one useful give it a like
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share it comment subscribe if you
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haven't already good luck for those cash
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flow statements this is an area that a
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lot of people struggle with but I
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promise if you follow the steps that I
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just showed you you'll be fine
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see you next time
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[Music]
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you
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