The CASH FLOW STATEMENT for BEGINNERS

Summary

This video introduces beginners to the Cash Flow Statement, explaining its importance and how it tracks a business's cash inflows and outflows. It contrasts the cash and accrual accounting methods, highlighting why businesses using the accrual method need both an Income Statement and a Cash Flow Statement. The video covers the structure of the Cash Flow Statement, detailing cash flows from operating, investing, and financing activities. It also compares the direct and indirect methods of preparing the statement, walking viewers through an example using the indirect method to show how cash movements reconcile with the Balance Sheet.

Takeaways

• 💡 The Cash Flow Statement summarizes a business's cash inflows and outflows over a specific period.
• 🔄 Two accounting methods exist: the cash method (cash recognized when received/paid) and the accrual method (revenue/expenses recognized when earned/incurred).
• 📉 Small businesses often use the cash method, but larger businesses must follow IFRS or GAAP, requiring accrual accounting.
• 📊 In accrual accounting, a separate Cash Flow Statement is needed in addition to the Income Statement and Balance Sheet.
• 🛠️ The Cash Flow Statement is divided into three sections: cash flows from operating, investing, and financing activities.
• 🔎 The direct method mirrors the cash method Income Statement but is less commonly used due to its complexity in preparation.
• 💰 The indirect method begins with net profit or loss and adjusts for non-cash expenses and working capital movements.
• 📉 Depreciation, amortization, and gains/losses on asset sales are non-cash expenses that need to be reversed out.
• 📥 Working capital adjustments include increases in receivables (which reduce cash flow) and changes in payables.
• 🧾 Tumble's Cash Flow Statement, using the indirect method, reconciles its net increase in cash for the year ($3.1 million).

Q & A

What is a Cash Flow Statement?

A Cash Flow Statement is a financial statement that summarizes a business's cash inflows and outflows over a period of time, providing insight into how cash is generated and spent.

Why is a Cash Flow Statement important for businesses using the accrual method?

In accrual accounting, revenue is recognized when earned, and expenses are recorded when incurred, which doesn't reflect actual cash movement. The Cash Flow Statement helps track real cash inflows and outflows, making it essential for businesses to assess liquidity.

What are the three main sections of a Cash Flow Statement?

The three main sections are: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities.

How does the direct method of preparing a Cash Flow Statement differ from the indirect method?

The direct method lists actual cash receipts and payments from operating activities, while the indirect method starts with net profit or loss and adjusts for non-cash items and changes in working capital.

Why is the indirect method more commonly used than the direct method?

The indirect method is easier for accountants to prepare because it relies on figures already available in the Income Statement and Balance Sheet, whereas the direct method requires more detailed tracking of cash transactions.

What are operating activities in the context of a Cash Flow Statement?

Operating activities are the core revenue-generating activities of the business, such as selling goods or services, and include cash inflows from customers and outflows to suppliers, employees, and taxes.

What kinds of transactions are included in investing activities?

Investing activities involve buying or selling long-term assets like equipment, property, or investments. Cash outflows occur when assets are purchased, and inflows come from selling those assets.

How do financing activities affect cash flow?

Financing activities include transactions that raise or repay capital, such as borrowing from banks, issuing shares, repaying loans, or paying dividends to shareholders.

What adjustments are made in step two of the indirect method?

In step two, non-cash expenses like depreciation, amortization, and losses on asset sales are added back because they don't involve cash outflows, even though they reduce net profit.

How is working capital adjusted in the indirect method?

Working capital adjustments account for changes in current assets and liabilities. Increases in current assets (like receivables) reduce cash flow, while increases in current liabilities (like payables) increase cash flow.