Intro to Cash Flow Statements | Direct Method

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

Channel: Accounting Stuff

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Keywords: accounting, accounting basics, direct method, cash flow, direct method cash flow, accounting basics cash flow, cash flow accounting, cash flow statement, statement of cash flows, cash flow statement direct method, cash flow statement direct method example, direct method cash flow statement, accounting stuff, direct cash flow method, how to prepare a cash flow statement, cash flow basics, cash flow for beginners, accounting statements explained, financial statements

Id: Xy-yDw0gsgc

Length: 12min 12sec (732 seconds)

Published: Tue Nov 20 2018