The CASH FLOW STATEMENT for BEGINNERS - YouTube

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

if you'd like to sign up then you can click the join button

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