Prepare A Cash Flow Statement | Direct Method

in this video you'll learn how to prepare a cash flow statement using a direct method example with the help of the income statement and the balance sheet along with some T accounts [Applause] hey viewers i'm james and welcome to accounting stuff this is a place where i regularly post videos teaching accounting for beginners there's a whole playlist of these videos which you should be able to find up here in the corner i'm posting more and more of these videos all the time so consider subscribing to avoid missing out if you're a regular viewer here then we pick up from where we left off last time with paying a cash flow statement using a direct method example previously i showed you a cash flow statement for the Chudley cannons Quidditch team along with its corresponding income statement and balance sheet but if you missed part one is a link to that over here as well in this video we're going to rewind a bit and prepare that same cash flow statement using T accounts and both of these reports we're going to use the direct method as we work out each number as we piece it together we're going to start off with the easy ones and move on to the harder calculations as we progress so recommend watching this video through until the end to get a clearer picture of the whole process let's begin so here we have the cash flow statement for the Chudley cannons and the plan is we're going to recalculate all of these numbers directly from the income statement and balance sheet for the same period the 31st of December we will start at the top with cash flow from operating activities and work our way down through all three sections to cash flow from financing activities we're using the direct method today so cash flow from operating activities mirrors the layout of an income statement prepared under the cash basis so we have cash receipts from customers at the top which reflect our sales and below that we have cash paid to suppliers employees and the rest of the expense types operating activities are the principle revenue generating activities of a business so this section shows the cash that we receive or pay out during the course of our regular business the first line item that we're going to calculate is cash receipts from customers and to do this we're going to need to look at the movement in our accounts receivable balance I said in the intro that we'll need some t accounts so let's draw those out accounts receivable is an asset which is the a and dealer so it's a normal debit account that means our opening balance or our balance brought forward goes on the left side of the t account because debits always go on the left the accounts receivable balance increases as we make revenue because when we credit sales we debit accounts receivable so sales go on the left side as well and finally the closing balance or the balance carried forward also goes on the left because it's a normal debit account opening and closing balances for normal debit and credit accounts should always be on the same side as each other on the credit side of the t account which is on the right we have cash receipts from customers cash receives from customers reduces our accounts receivable and this is what we're looking to solve for because cash receipts from customers ties back to our cash flow statement now we've laid out our t account let's enter some numbers we get our opening balance from the balance sheet for the previous year in this case accounts receivable when $98,000 has had 31st of December for the prior year so we can write this down in the T account sales come straight from the income statement this year the cannons made sales of two hundred and fifty thousand dollars so we need to debit accounts receivable by 250 and finally our closing balance comes from the balance sheet this time from the current year accounts receivable at the end of the current year were one hundred and twenty thousand dollars so that goes on the Left at the bottom of the T account now we only have one missing value cash receipts from customers and we can work this out using some basic maths our closing balance of a hundred and twenty less our sales of 250 less our opening balance of ninety eight gives us minus two hundred and twenty eight the negative sign signifies that this is a credit so we write this down on the credit side of our t account as you can see this ties back to the two two eight that we have in our cash flow statement all as well next I'm going to skip over cash paid to suppliers and return back to a later in this video because it's actually one of the harder balances to calculate so instead we move on to cash paid to employees the balance sheet account that we're going to need for this one is salaries payable salaries payable is a form of liability the L in dealer so it's a normal credit account that means our opening balance goes on the right hand side of the t account because credits always go on the right the balance on this account increases as the salaries expense goes up because when we debit to the salaries expense and credit salaries payable so these go on the right and lastly the closing balance joins the opening balance on the right hand side because we have a normal credit account we are looking to solve the cash paid employees which will show as a debit on the left hand side of this t account because when we pay out cash to employees we reduce salaries payable this is the only unknown value for us at this stage because we can easily pull the opening and closing balances from the prior and current year balance sheet and we can get the salaries expense from the current year income statement so let's do that the prior year balance sheet shows a closing balance in salaries payable of 30 the current year income statement shows the salaries expense of 80 and the current year balance sheet shows a closing balance in salaries payable of 42 let's write these down in the t-account to work out cash paid to employees our closing balance of negative 42 less the salaries expense of 80 unless the opening balance of 30 gives us cash paid to employees of 68 this number is positive so we debit the t account by 68 and does it tie back to our cash flow statement yes it does perfect next up we need to work out interest paid we're going to run through this one a bit quicker because the balance sheet account that we use to work this out is interest payable which is also a liability so the process is very similar to cash paid to employees that means that the opening balance the interest expense and the closing balance all go on the right-hand side of the T accounts because interest payable is a normal credit account on the left side the debit side we are looking to solve the interest paid which you've tied back to the cash flow statement we are again going to look for the opening and closing bounces in the respective balance sheets and for the interest expense in the income statement so here we go the prior-year balance sheet shows a closing balance in interest payable of to the current ear balance sheet shows a closing balance in interest payable of three and the current year income statement shows an interest expense of eight so let's enter these into our t account to work out interest paid our closing balance of negative three less the interest expense of eight less the opening balance of two gives us interest paid of seven it's positive so we debit the t account by seven thousand when we check back against the cash flow statement we can also see interest paid of seven thousand Sarah matches the last line in cash flow from operating activities is income taxes paid which will work out now the balance sheet account we're going to need for this one is income tax payable and since that's also a liability the process is going to be very similar to the previous two examples the opening balance the income tax expense and the closing balance go on the right-hand side of the t account because we are dealing with a normal credit account on the debit side we have income tax paid which we're solving for the opening and closing balances will again come from the balance sheet and we will get the income tax expense from the income statement the prior-year balance sheet shows a closing balance in income tax payable of for the current year balance sheet shows closing balance of six and to the income statement shows an income tax expense of nine we enter these into the t account to work out income tax paid our closing balance of negative six less the income tax expense of nine less the opening balance of four gives us income taxes paid of seven so we debit the t account by seven thousand and this ties back to income taxes paid in the cash flow statement who how did you find that brace yourselves because we're about to take on something a bit more challenging we're going to head back to cash paid to suppliers which we left out earlier and I'll show you how to calculate the balance sheet accounts that we need here is accounts payable which is a liability now you might be thinking but James we just did three liability accounts isn't the process going to be exactly the same bear with me for a moment and I'll explain why it's different we lay out the accounts payable t account as we've done before the opening balance inventory purchased and closing balance go on the credit side and cash paid which we're solving for again goes on the debit side we can easily pull the opening and closing balances than the prior and current ear bar and sheet in this case we have an opening balance of 95 and a closing balance of 105 so all we need now is inventory purchased and we're on our way but how do we find inventory purchased there isn't an inventory expense in the income statement all we have is cost of goods sold bummer what we have to remember here is the real accounting using the accrual basis and under the accrual basis we apply the matching principle which states that revenue and all expenses incurred in order to generate that revenue need to be recognized in the same accounting period now what that means for us in the context of this example is that when we purchase goods from suppliers that we intend to sell we can't immediately recognize an inventory expense in the income statement that's because our intention is to sell our inventory in order to generate sales and if we generate in sales then the matching principle is telling us that we need to recognize those sales and their related expenses in the same accounting period in order to do that we need the help of another account inventory having an inventory account means that we can store the costs of all goods that are intended to be sold as a debit balance in the balance sheet and when they are sold we decrease inventory in the balance sheet an increased cost of goods sold in the income statement let me explain this using an inventory t-account inventory is a form of asset which makes it a normal debit account so the opening balance inventory purchases and to the closing balance go in the debit side on the credit side we have cost of goods sold we can easily find the opening and closing balances by referring to the prior and car here balance sheet here we have an opening balance of 68 and a closing balance of 94 which we will write down in our T account and we can find cost of goods sold in the income statement which in this case is 60 so he writes 60 on the credit side of the t account because when we sell inventory we debit to the income statement to recognize the expense and we credit inventory in the balance sheet to reduce our assets that leaves us with inventory purchases which we can work out using the other numbers a closing balance of 94 less the opening balance of 68 and adding back cost of goods sold of 60 gives us inventory purchases of 86 so we debit the T account by 86 you might have noticed already that it was inventory purchases that we were looking for in our accounts payable t account so we can copy the 86 over to the credit side of accounts payable because when we purchase inventory we debit inventory to increase it and credit accounts payable to increase the amount that we owe to suppliers now that we've worked out that number were on the home straight calculating cash paid to suppliers our closing balance of negative 105 less inventory purchases of 86 less our opening balance of 95 gives us cash paid to suppliers of 76 which goes on the debit side of the accounts payable T account and ties back to our cash flow statement ouch did you survive that cash paid to suppliers is definitely one of the hardest numbers to calculate on the cash flow from operating activities if you'd like to learn more about school accounting then I throw a link up here to a video that I've made about it previously so that was cash flow from operating activities and when we subtotal all of these numbers that we worked out we can see that the cannons have generated $70,000 of cash inflow from their core operations now hold your horses were not done yet next up we have cash flow from investing activities investing activities most commonly relate to the sale or purchase of non current assets or investments in stocks and shares that sits outside of a business's core operations in this cash flow statement we are cash flowing out of the business from the purchase of pawned property and equipment or PPE for short and cash flowing back in from the sale of PPE you might have guessed it already but the balance sheet account that we need to calculate these numbers is plant property and equipment this account is an asset which is the a in dealer so it's a normal debit account and therefore our opening and closing balances go on the left hand side on the credit side we have the depreciation expense because the value of non current assets reduce as they depreciate credits non current assets in the balance sheet debit depreciation expense in the income statement now I don't want to over complicate things in this tutorial so we're going to keep PPE simple and make a few assumptions at this point we're going to ignore accumulated depreciation assume no gain or loss on disposal and that all cash related to these transactions has changed hands and finally that the cañon spent seventy thousand dollars purchasing PPE this year I know that's a lot of assumptions but we don't have a fixed asset register for this example so we'll leave it at that I'll probably do a whole video in the future covering fixed assets and depreciation now that we've cleared that up all this left to include our cash paid to purchase PPE and cash receipts on sale of PPE the prior year balance sheet shows a closing balance in PPE of 202 the current year balance sheet shows closing balance of two three four and we can see that the depreciation expense in the income statement was 23 I just said that we can assume that the cañon spent 70,000 on the purchase of PPE and that all their cash has changed hands so we would credit cash by 70 to decrease it and debit PPE by 70 to increase it that leaves us with cash receipts from the sale of PPE on the credit side which we now need to solve for a closing balance of 2/3 for less cash paid of 70 less an opening balance of 202 and adding back the depreciation expense of 23 gives us cash receipts on the sale of PPE of 15 so cash would be debited by 15 to increase it and PPE would be credited by 15 to decrease it both cash paid to purchase PPE and cash receipts on the sale of PPE tie back to our cash flow statement and when we subtotal all of these we see a cash outflow of 55,000 from investing activities cash flow from investing activities is an important section of the cash flow statement because it can significantly offset the cash flow generated from operating activities last up we have cash flow from financing activities and don't worry we've got all that hard work out of the way this section is going to be quick financing activities related transactions involving a businesses owners lenders in this case we're dealing with lenders because we have proceeds from long term borrowings of 20,000 and the number is very simple to calculate we take the closing balance of long term borrowings in the current year balance sheet of 100 and we take away the closing balance from the previous year of 8100 les 80 is 20 so we have a net cash inflow of 20,000 from financing activities now let's take the total of all these cash inflows and outflows that we have worked out we can see that the cannons have a net cash increase of $35,000 for the current year which ties to the movement in the cash balance which we can see below and which we can get from the balance sheet the closing cash balance for the current year of 185 less the closing balance from the prior year of 150 gives us a $35,000 increase in cash so there we have prepared the Chudley cannons cash flow statement using the direct method working out all of the numbers manually in the income statement and balance sheet woah that was hard work wasn't it and this is only a simple example you can imagine that this whole process is more complicated for larger companies with more complex transactions which is why most of them actually avoid this process altogether because it can be too expensive and time-consuming for their accountants to work out cash flow using the direct method the majority of large corporations tend to offer the indirect method instead which is the subject of our next video the indirect method has the benefit have been much easier to prepare however it's less useful to investors and I'll explain why next time thanks for watching today's video if you found it useful like it share it comment subscribe I power new videos every Monday here on counting stuff see you in the next one

Channel: Accounting Stuff

Views: 237,620

Keywords: direct method, t accounts, cash flow, cash flow statement, cash flow t account, direct method t account, cash flow accounting, accounting basics cash flow, direct method cash flow, cash flow statement t accounts, cash flow statement using t accounts, accounting basics, cash flow statement direct method, direct method example, accounting stuff, direct method cash flow statement, direct cash flow method, how to prepare a cash flow statement, t account, t account tutorial

Id: KOR10VPsyO8

Length: 18min 13sec (1093 seconds)

Published: Tue Dec 04 2018