Statement of Cash Flows (Indirect Method)

In this video we're going to talk about how to prepare a statement of cash flows using the indirect method. So a statement of cash flows is laid out as follows we've got cash flows from operations and then we've got cash flow from investing activities that's like selling fixed assets or securities cash flow from financing right issuing dividends and so forth raising money from lenders and all of these three things here are going to be netted together and we're going to come up with the change in cash over the period so if you need a little more detail i've got videos on each of these feel free to check them out but i'm just going to jump right in and with an example so let's say that we have the following activities happen for our company and let's say it's a startup company it's brand new and we're just going to build a statement of cash flows from scratch so we issue fifty thousand dollars in common stock that's how the company's going to be financed so it's financed a hundred percent with equity you got fifty thousand dollars in common stock and then the company goes and buys twenty thousand dollars of inventory for cash and they sell all that inventory for forty five thousand dollars thirty five thousand of which they receive in cash ten thousand of which is credit accounts receivable then they incur fifteen thousand in operating expenses during the year on credit so accounts payable they purchase equipment for eight thousand dollars also on credit and we'll call that accounts payable could have been a note or something like that to a no payable but in this case we'll say it just goes to accounts payable and then they pay a cash dividend to the equity holders they get five hundred dollars at some point during the year so all this this is our activity for our new company during the year we're going to make this simple we're going to assume there's no taxes no depreciation on that equipment no bad debt or uncollectible accounts just really want to show you the basics of how we put together a statement of cash flow so we're going to need a couple of things to make this a little bit easier we're going to need an income statement prepared an income statement so we can have net income because net income is going to be the first line on our statement of cash flow so we need an income statement i've calculated out from our sales and our cost of goods sold and so forth from the preceding information we come out with a net income of ten thousand dollars then we've got comparative balance sheets right so we've got let's say january 1st is when we started our company and then december 31st is the end of the year so we just completed a balance sheet for each point in time january 1st was easy because we hadn't even started operations yet so just everything is zero and then here are our account totals as of december 31st balance sheet so we can use these numbers and the changes in these balance sheet accounts to prepare our statement of cash flow so let's get into that so our statement of cash flows again we're going to start with this net income of ten thousand dollars so let's let's i'm going to make a little room here we've got our state statement of cash flow so our net income we got our cash flow from operations remember we said we start with that cash flow from operations and we've got net income of ten thousand dollars i'm going to put that ten thousand right here now we need to make adjustments to net income why do we do that well like we talked about in the video with cash flow from operations net income includes a lot of accruals things that don't have anything to do with cash right so we need to back out some of these effects for example what's happening with accounts receivable and what's happening with account payable so now let's go back to our account so we see that we have an increase in accounts receivable of ten thousand dollars so that's actually when we are increasing our account receivable we're not that that increase we had sales and revenue that was the corresponding entry with that that increased our net income but it didn't affect cash right so this ten thousand was not receiving cash so basically when we have an increase in account receivable that's going to be a negative number on our statement cash flow that's going to be a use of cash so we'll put negative ten thousand right here and then conversely for our increase in accounts payable right we incurred these expenses or purchases of equipment or different things but we didn't pay out cash yet right this is credit that we got so we basically had an increase of credit here of twenty three thousand dollars that was and so now that is going to be a positive number on our statement now what we do we take these numbers and we net them we take the net effect here i'm going to change colors make it really easy for you to see too so we're going to have a net effect net cash provided by operation of twenty three thousand dollars that's right net cash provided by operation that's just the sum total of this right here now we calculate our cash flows from investing this is sale of fixed assets in this case there's a purchase of the fixed asset this equipment so that equipment costs eight thousand dollars so we're going to have a negative cash outflow here eight thousand dollars that just simply reflects that we paid eight thousand dollars to get equipment now you might say hey wait a minute we didn't actually pay cash for that equipment we put it on credit and went to accounts payable and i would say yes that's true but we just accounted for the change in accounts payable here right so it all evens out okay so we have this negative eight thousand dollars and now we can come up with since that's our only transaction net cash used by investing activity and that's going to be eight thousand dollars i've got it in parentheses to indicate it's a negative number so when you look at this this net cash used by investing activity so we've got used instead of provided with operations that means it's negative right so this means if we look at all the investing activities which in this case there was just one investing activity but we put them all together we actually used more cash than we generated but with operations it's different we provided we were provided with cash by our operations because it's a positive number so now we go to our final component so we have the operations we have cash from investing activities and now cash from financing activities this is like dealing with with lenders with with our equity holders so people will hold stock in our company so now we issued stock and we issued stock of fifty thousand dollars so what is that going to be well that's going to be a positive number right because when we issue stock we're getting cash we're giving out stock to our shareholders and we're getting cash in return and we got fifty thousand dollars so that's what we enter and that's a positive number now we also paid out a dividend to our our shareholders so that's going to be negative right because we paid out this dividend of five hundred dollars and so now we can go and calculate calculate the net effect the net cash of our financing activity so we've got here forty nine thousand five hundred dollars and that's again that's just the sum of these two fifty thousand minus five hundred and this is a positive number so of course it says net cash provided by financing activities okay so now we can go and say what is the net increase or decrease in cash that we've had during the period so we've had an increase so let me just change the colors again and make this crystal clear for you so we had a net increase of cash of sixty four thousand five hundred dollars now how did i compute that well i took the net cash provided by operations net cash used by investing net cash provided by financing we sum those together and that gives us sixty four thousand five hundred dollars so if somebody said what happened to cash during the period we say it went up sixty four thousand five hundred dollars and now just to really make things clear for somebody who's using our financial statements we say what was our beginning cash balance and what was the ending cash balance well this was pretty simple because we were a startup company we started with zero then we ended the year with sixty four thousand five hundred dollars