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Intro to Cash Flow Statements | Direct Method - YouTube
Channel: Accounting Stuff
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in this video you'll learn what the
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statement of cash flow is and how to
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prepare it using the direct method hey
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viewers welcome back to another episode
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of accounting staff I'm James and today
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I would like to introduce you to the
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cash flow statement three weeks ago I
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made a video about the accrual basis of
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accounting and I said something along
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the lines of the accrual basis of
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accounting doesn't explicitly track cash
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flow so this needs to be calculated
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separately using the direct or indirect
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method after I posted that video I
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received a couple of comments from you
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guys asking me to explain the cash flow
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statement and the direct and indirect
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methods
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hence today's video and don't worry a
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lot of people get intimidated by the
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statement of cash flows but I promise
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you there is really no reason to be you
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might have heard the expression cash is
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king well in this video I'm going to
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explain why the cash flow statement is
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so important and how to prepare it using
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the direct method we are going to cover
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the direct method first because it's
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considered to be more valuable to
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investors what anyone who reads the cash
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flow statement however many people opt
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for the indirect method instead if
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you'll stick around with me until the
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end I'll explain why right I think
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that's enough bang let's get started
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first I want to make one thing very
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clear cash and profit are not the same
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thing profit is revenue less expenses is
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the bottom line on an income statement
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and relates to a period of time whereas
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you can think of cash as a bank balance
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at a point in time cash and cash
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equivalents also include physical petty
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cash amongst a few other things
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although most conventional companies use
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bank accounts just like you or I might
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have I also want to make the point that
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cash flows are different to cash cash
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flows relate to the amount of cash that
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is flowed in or out of a business over a
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period of time now that might sound a
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bit more like profit but it isn't
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when using the accrual basis of
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accounting we apply the revenue
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recognition and matching principles so
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that means that revenue is recognized as
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it's earned not when cash is received
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and expenses are recorded as they are
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incurred not when cash is paid out that
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means revenue doesn't equal cash in and
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expenses doesn't equal don't equal cash
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out the biggest reason that small
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businesses bail is because of poor cash
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flow management many of these businesses
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would have been profitable but without
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having that cash available they're
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unable to pay their staff their
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creditors or the interest on their bank
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loans and this throttles them that
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expression that I mentioned a moment ago
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cash is king
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is used to emphasize the importance of
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cash flow particularly in small
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businesses now I feel like I'm harping
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on about this so it's time to move on
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but I can't stress this point enough it
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is crucial to keep a track of your cash
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flows and we do that using the cash flow
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statement or statement of cash flows
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this is one of the three main financial
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statements along with the income
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statement and balance sheet we have all
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three of them here made up for a company
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called Chudley cannons incorporated I
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apologize for Harry Potter reference but
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I've been real istening to the audio
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books by Stephen fryer when I go to bed
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and I'm not gonna lie it's been amazing
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I get to dream about sneaking through
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Hogwarts every night to my visibility
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kulluk it's great audible is offering a
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free 30-day trial at the moment and they
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have all the books so you can check them
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out too I'll stick a link to it in the
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description below but that's enough
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Harry Potter chat for now back to the
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cash flow statement the first thing to
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note is that the cash flow statement
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covers a period of time and we put this
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in the header remember I said that cash
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flows relate to the amount of cash that
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has blowed in or out of a business over
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a period of time here we have the year
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ended the 31st of December but this
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could easily cover a quarter or a month
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I think it's easiest to interpret the
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cash flow statement by starting at the
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bottom and working our way back up at
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the bottom we have cash at the start and
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end of the year which we get from the
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balance sheet over here
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when we take the difference between
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these numbers we get the net increase or
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decrease in cash for the year in this
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case it's $35,000 this number is key to
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the statement of cash flows because what
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we're going to do above is explain how
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and why the cash balance changed over
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the course of the year we're going to
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summarize what cash was spent on and
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what the sources were and reconcile it
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all back to this number and we do this
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by breaking it all down into three
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sections the last section is cash flow
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from financing activities financing
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activities include changes to share
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capital borrowings from a bank or from
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third parties here we have long term
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borrowings which I assume were from
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gringos the wizarding bank when a
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company borrows money there's a cash
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inflow so your cash balance increases
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that's the case here since you can see
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that we have a cash inflow of $20,000
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because the number is positive but cash
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can also flow out of a business through
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financing activities when you pay back a
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loan or buy bag share capital above
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financing activities we have cash flows
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from investing activities investing
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activities most commonly relate to the
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sale or purchase of non current assets
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or investments in stocks and shares that
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sit outside of the business's core
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operations when a business invests in
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non current assets cash flows out
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because we have to pay the suppliers
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cash for these assets and on the flip
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side when we sell these assets off cash
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flows back in here the Chudley cannons
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have 15,000 dollars of cash inflow from
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the sale of PPE which is shorthand for
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plant property and equipment and 70,000
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dollars of cash outflows from the
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purchase of PPE they are a Quidditch
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team so they might have received the
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$15,000 by selling off their old
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broomsticks in order to buy some of
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those new Nimbus 2000 and once which
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cost them $70,000 this is an investing
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activity not an operating activity
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because buying and selling broomsticks
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it's not the Chudley cannons core
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business the broom stakes are long-term
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investments which makes them non current
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as
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this is different to inventory which
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describes assets that are intended to be
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sold during the ordinary course of
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business which brings us on to the first
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section of the statement of cash flows
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cash flow from operating activities
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operating activities are the principal
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revenue generating activities of a
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business that sounds like a mouthful but
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it just means the cash that we receive
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or pay out during the course of our
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regular business cash comes in when our
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customers pay us based on our accounts
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receivable and cash flows back out when
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we pay our suppliers based on our
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accounts payable now the start of the
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video I mentioned the direct and
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indirect methods of preparing a cash
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flow statement and I haven't brought
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them up again until now because
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everything that we've covered so far is
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identical under each method operating
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activities is the only section that's
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different today I'm going to cover the
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direct method and soon I'll do another
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video on the indirect method you can
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subscribe to the channel so you don't
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miss out so the direct method under the
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direct method the cash flow from
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operating activities is laid out just
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like a cash basis income statement under
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the cash basis of accounting revenue is
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recognized when cash is received and
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expenses are recorded when cash is paid
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out when you work out your operating
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profit under this method it should match
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your cash flow from operating activities
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let's check back on the Chudley cannons
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this cash flow statement has been
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prepared under the direct method so
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under operating activities we first have
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cash receipts from customers of two
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hundred and twenty eight thousand
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dollars the cannons are sport team so I
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would assume that the majority of these
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earnings would come from ticket sales
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and the sale of merchandise this 228 Kay
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of cash in would match their revenue for
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the same period if they were cash
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counting but we can see that their
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income statement and balance sheet have
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been prepared under the accrual basis we
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know this because their income statement
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shows depreciation which is a non-cash
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transaction so it wouldn't show up in an
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income statement prepared under the cash
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basis
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their balance sheet also contains
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inventory receivables and payables none
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of which would appear in a cash basis
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balance sheet so we've covered cash
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receipts but the next four lines under
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the cash flow from operating activities
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all relate to cash paid out cash paid
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out to suppliers employees interest paid
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and income taxes paid when you compare
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this to the income statement you can see
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that each line relates to one of the
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expense types cash paid to suppliers
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relates to cost of sales cash paid to
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employees relates to the salaries
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expense interest paid relates to the
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interest expense and income taxes paid
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relates to the income tax expense
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there is no depreciation in this cash
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flow statement because depreciation is a
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non-cash transaction so that's the three
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sections of the cash flow statement and
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when we subtotal these we get 70k of
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cash in from operating activities 55k of
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cash out through investing activities
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and finally 20k of cash in from
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financing activities if we add all these
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together we get a net increase in cash
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of $35,000 which reconciles back to the
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movement of the cash balance in the
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balance sheet a closing balance of a
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hundred and eighty five K less the
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opening balance of a hundred and fifty K
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is also $35,000 that's the statement of
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cash flows prepared under the direct
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method it's a really handy report for
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investors to read over because you can
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easily identify where cash flowed in and
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where it flowed out we can see that 76 K
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was given out to suppliers which was our
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biggest cash outflow it's intuitive so
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is the preferred method of producing a
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cash flow statement however at the start
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I said that many people go for the
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indirect method instead now why is that
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the thing is the cash flow from
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operating activities can be tough to
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work out using the direct method
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particularly for large companies using
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the accrual basis of accounting it can
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be costly and time-consuming to go
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all the information you need to put it
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together the indirect method is an
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easier alternative which is why most
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corporations favorite even though it's
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harder for investors to understand both
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methods are allowed under GAAP and IFRS
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and although the direct method is
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preferred
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most companies opt for the indirect
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method instead how did you guys find
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that the cash flow statement can be a
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hard nut to crack but I think we packed
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a lot in there I think this topic is
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deserving of two more videos which I'll
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put up shortly in the next one we'll get
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our hands dirty as we've reproduced this
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cash flow statement with the direct
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method from scratch using only the
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income statement the balance sheet and
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the help of some tea accounts if you
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want to fully understand this topic then
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I highly recommend you check that one
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out because seeing everything getting
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piece together will make things much
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clearer thanks for watching if you found
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this video useful give it a like share
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it comment subscribe if you haven't
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already I put out new videos every
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Monday here on accounts and stuff see
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you in the next
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you
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