The CASH FLOW STATEMENT for BEGINNERS

James from Accounting Stuff provides a beginner-friendly overview of Cash Flow Statements, emphasizing their importance in financial reporting. He explains the difference between the cash and accrual accounting methods, noting that the latter requires separate Cash Flow Statements, Income Statements, and Balance Sheets. James outlines the structure of a Cash Flow Statement, detailing cash flow from operating, investing, and financing activities. He compares the direct and indirect methods, highlighting the ease of the indirect method due to its reliance on Income Statement and Balance Sheet data. Using a fictional company, Tumble, he demonstrates how to create a Cash Flow Statement using the indirect method.

• A Cash Flow Statement is a financial document that summarizes a business's cash inflows and outflows over a given period.
• Understanding the Cash Flow Statement is crucial for differentiating between cash and accrual accounting methods.

"A Cash Flow Statement is a financial statement that summarizes a business's cash inflows and outflows over a period of time."

• This quote defines the primary purpose of the Cash Flow Statement, highlighting its role in tracking financial transactions.

• The cash method recognizes revenue when cash is received and records expenses when cash is paid out.
• The accrual method recognizes revenue as it is earned and records expenses as they are incurred.
• The cash method results in a financial statement equivalent to a Cash Flow Statement, while the accrual method requires a separate Cash Flow Statement.

"In accounting, there are two main methods for preparing your books: the cash method and the accrual method."

• This quote introduces the two primary accounting methods, setting the stage for understanding their differences.

"With the cash method, you recognize your revenue when cash is received and you record your expenses when cash is paid out."

• Highlights the cash method's approach to handling transactions, focusing on actual cash flow.

"Under the accrual method, you recognize revenue as it's earned and record your expenses as they are incurred."

• Explains the accrual method's focus on recognizing transactions irrespective of cash movement.

• The cash method is not permitted under International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP).
• Businesses using the accrual method must maintain separate financial statements: Income Statement, Cash Flow Statement, and Balance Sheet.

"The cash method isn't allowed under IFRS or GAAP."

• This quote underscores the regulatory limitations of the cash method, emphasizing the necessity of the accrual method for compliance.

• The Cash Flow Statement begins with the opening cash balance and ends with the closing cash balance, explaining the net change in cash.
• It consists of three sections: cash flow from operating activities, investing activities, and financing activities.

"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."

• This quote outlines the fundamental structure of the Cash Flow Statement, focusing on the starting and ending cash balances.

• Includes cash flows from the main revenue-generating activities of the business, such as selling goods or services.

"Operating activities are the main revenue-generating activities of the business."

• This quote identifies the core focus of operating activities within the Cash Flow Statement.

• Encompasses cash flows related to buying or selling investments or long-term assets, which are outside the core operations.

"Investing activities sit outside of the business's core operations."

• Highlights the non-operational nature of investing activities and their impact on cash flow.

• Involves cash flows related to raising or repaying funds, either from third-party banks or business owners.

"Financing activities relate to funding the business through raising or repaying cash to third-party banks or the owners of the business."

• This quote explains how financing activities affect the business's cash flow, focusing on funding sources.

• The Cash Flow Statement provides insights into how a business generates and uses cash, helping stakeholders understand the financial health and operational efficiency.

"This, my friends, is the basic structure of the Cash Flow Statement."

• Concludes the explanation of the Cash Flow Statement's structure, emphasizing its role in financial analysis.

• Direct Method:
  • The direct method of cash flow from operating activities mirrors the Income Statement prepared under the cash method.
  • Key components include cash receipts from customers (mirroring revenue) and cash paid out to suppliers, employees, interest, and taxes (mirroring expenses).
  • Cash flow from investing activities involves cash outflows from buying investments or long-term assets and inflows from selling them.
  • Cash flow from financing activities involves raising or repaying cash or capital through liabilities or equity.

"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."

• Explanation: This quote outlines the structure of the direct method, highlighting how cash receipts and payments align with revenue and expenses.

• Indirect Method:

  • The indirect method begins with the net profit or loss from the Income Statement.
  • Non-cash expenses like depreciation and amortization are added back as they do not represent cash outflows.
  • Adjustments are made for movements in working capital, with increases in current assets reducing cash flow and increases in current liabilities increasing cash flow.

"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."

• Explanation: This quote explains the starting point and the adjustments needed in the indirect method, emphasizing its reliance on net profit and non-cash expenses.

"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."

• Explanation: This quote describes the adjustments for working capital, detailing how changes in current assets and liabilities affect cash flow.

• The direct method is easier to read but harder for accountants to prepare, leading to less frequent use.
• The indirect method is easier to work out due to the availability of numbers in the Income Statement and Balance Sheet.

"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."

• Explanation: This quote compares the ease of preparation and usage between the two methods, highlighting the practicality of the indirect method for accountants.

• The example uses the indirect method for a fictional business called Tumble, a dating app.
• The process requires an Income Statement, which summarizes Tumble's revenues and expenses for the year ended December 31st.

"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."

• Explanation: This quote introduces the practical application of the indirect method using a fictional example, setting the stage for understanding how to prepare a Cash Flow Statement.

• The Balance Sheet provides a snapshot of assets, liabilities, and equity at the end of the year.
• Using the indirect method requires examining both the current and previous year's Balance Sheets.
• Tumble's comparative Balance Sheet shows the current year on the left and the previous year on the right.

"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."

• The Balance Sheet reveals the financial position at a specific point, and the indirect method necessitates comparison with the previous year for accurate analysis.

• Tumble sold furniture for $10,000, originally costing $20,000, with $5,000 depreciation, resulting in a loss charged to general and admin expenses.
• The company invested $910,000 in computer equipment.
• Tumble raised $100,000 in long-term debt without making any repayments.
• Issued $50,000 in common stock and paid $1,000,000 in dividends.

"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."

• The sale of furniture resulted in a financial loss due to depreciation, impacting the company's general and administrative expenses.

• The focus is on reconciling cash, as it is a Cash Flow Statement.
• Last year's cash was $13,895,000, which increased to $17,000,000 this year.
• The net increase in cash is $3,105,000.

"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."

• The increase in cash by $3,105,000 is a crucial aspect of the Cash Flow Statement, indicating financial growth.

• Step 1: Determine Tumble's net profit or loss for the current year, which is $9,650,000 from core operations.
• Step 2: Reverse non-cash expenses like depreciation and amortization, totaling $850,000.
• Include the $5,000 loss on the sale of furniture as a non-cash expense to be reversed.

"This year Tumble incurred $850,000 in non-cash expenses so we'll add this back in our cash flow from operating activities."

• Non-cash expenses such as depreciation do not affect cash flow directly and need to be added back to calculate cash flow from operations accurately.

• Working capital is the difference between current assets and current liabilities, excluding cash.
• Tumble's receivables increased from $8,850,000 last year to $14,050,000 this year, indicating a $5,200,000 increase.

"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."

• Understanding the movement in working capital is essential for adjusting cash flow from operating activities, as it impacts the liquidity and operational efficiency of the company.

• An increase in receivables reduces cash flow because it indicates that more money is owed to the company.
• A decrease in payables results in reduced cash flow as it suggests more supplier accounts have been settled.
• Tumble's net cash inflow from operating activities, after adjustments, was $4,855,000.

"An increase in receivables reduces cash flow so we subtract $5.2 million from cash flow from operating activities."

• This quote explains how an increase in receivables negatively impacts cash flow because it represents money owed to the company that has not yet been received.

"That's a year-on-year decrease in payables of $450,000 we subtract decreases in payables under cash flow from operating activities."

• A decrease in payables is subtracted from cash flow, indicating that more cash was used to settle supplier accounts.

"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."

• This statement summarizes the net cash inflow from operating activities after adjusting for non-cash expenses and working capital changes.

• Cash outflows occur when purchasing long-term assets, such as computer equipment.
• Cash inflows occur from selling long-term assets, even if they are not part of the core business.
• Tumble's net cash flow from investing activities was a negative $900,000, indicating an outflow.

"Tumble spent $910,000 on computer equipment this is a cash outflow from investing activities because they bought long-term assets."

• Purchasing long-term assets results in cash outflows, impacting the cash flow from investing activities.

"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."

• Despite the loss, the sale of an asset brings cash inflow, which is recorded under 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."

• The net result of investing activities is a cash outflow, reflecting the purchase and sale of assets.

• Financing activities involve raising or repaying cash or capital for business funding.
• Tumble raised $100,000 in long-term debt and issued $50,000 in common stock, increasing cash inflows.
• Dividends of $1,000,000 paid to shareholders resulted in cash outflows, leading to a net cash outflow of $850,000 from financing activities.

"Tumble raised $100,000 in long-term debt this is a liability to a third-party bank."

• Raising long-term debt increases cash inflow but also increases liabilities.

"They issued $50,000 in common stock which is a capital contribution from the shareholders who own the business which increases equity."

• Issuing common stock results in cash inflow and increases the company's equity.

"They paid $1,000,000 out in dividends back to these shareholders that would have decreased their equity."

• Paying dividends results in cash outflow and reduces the company's equity.

• The total cash flows from operating, investing, and financing activities resulted in a net increase in cash of $3,105,000 for Tumble.
• This net increase reconciles with the movement in cash observed in the Balance Sheet.

"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."

• The overall cash flow analysis shows a net increase, reflecting the cumulative effect of operating, investing, and financing activities.

"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."

• The reconciliation confirms the accuracy of the cash flow statement and its alignment with the Balance Sheet.