The CASH FLOW STATEMENT for BEGINNERS
TLDRThe video introduces the Cash Flow Statement, a financial document summarizing a company's cash inflows and outflows over a period. It explains the necessity of this statement, especially in accrual accounting, and contrasts it with the Income Statement and Balance Sheet. The video outlines the three main sections of the Cash Flow Statement: operating, investing, and financing activities, and describes the direct and indirect methods for preparing it. A detailed example using a fictional dating app company, Tumble, illustrates the preparation of the statement using the indirect method, highlighting the adjustments for non-cash expenses and changes in working capital.
Takeaways
- π A Cash Flow Statement is a financial document that summarizes a business's cash inflows and outflows over a period of time.
- π° The necessity of a Cash Flow Statement arises from the difference in recognizing revenue and expenses between cash and accrual accounting methods.
- π In cash accounting, the Income Statement is equivalent to the Cash Flow Statement, but this method isn't allowed under IFRS or GAAP for businesses following these standards.
- π The Cash Flow Statement has three main sections: cash flow from operating activities, investing activities, and financing activities, each reflecting different financial aspects of the business.
- π Operating activities involve the main revenue generating activities of the business, such as selling goods or services.
- π’ Investing activities pertain to the purchase or sale of investments or long-term assets that are outside the business's core operations.
- πΌ Financing activities relate to the funding of the business through raising or repaying cash to third-party banks or the business owners.
- π There are two methods to prepare a Cash Flow Statement: the direct method, which mirrors the cash method Income Statement, and the indirect method, which starts with net profit or loss from the Income Statement.
- π The indirect method is more commonly used because it's easier to prepare, leveraging numbers from the Income Statement and Balance Sheet.
- 𧩠To create a Cash Flow Statement using the indirect method, adjustments are made for non-cash expenses, such as depreciation and amortization, and changes in working capital.
- π The final Cash Flow Statement should reconcile the net increase or decrease in cash with the movement in the Balance Sheet, providing a clear picture of the business's cash position over the period.
Q & A
What is the primary purpose of a Cash Flow Statement?
-The primary purpose of a Cash Flow Statement is to summarize a business's cash inflows and outflows over a period of time, providing insight into the liquidity and financial flexibility of the company.
What are the two main methods for preparing financial statements in accounting?
-The two main methods for preparing financial statements in accounting are the cash method and the accrual method.
How does the cash method differ from the accrual method in terms of revenue and expense recognition?
-Under the cash method, revenue is recognized when cash is received and expenses are recorded when cash is paid out. In contrast, the accrual method recognizes revenue as it's earned and records expenses as they are incurred, regardless of cash transactions.
What financial statement is equivalent to a Cash Flow Statement under the cash method?
-Under the cash method, the Income Statement is equivalent to a Cash Flow Statement since it only accounts for transactions when cash is exchanged.
Why is the cash method not allowed under IFRS or GAAP?
-The cash method is not allowed under IFRS or GAAP because these accounting standards require revenue to be recognized as it's earned and expenses to be recorded as they are incurred, which is not the case with the cash method.
What are the three main sections of a Cash Flow Statement?
-The three main sections of a Cash Flow Statement are cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities.
What types of activities are included in operating activities in a Cash Flow Statement?
-Operating activities in a Cash Flow Statement include the main revenue generating activities of the business, such as the cash flows involved in selling goods or services.
How does the indirect method for preparing a Cash Flow Statement differ from the direct method?
-The indirect method begins with the net profit or loss from the Income Statement, adds back non-cash expenses, and adjusts for changes in working capital. It is easier for accountants to prepare than the direct method, which mirrors the Income Statement prepared under the cash method and lists all cash receipts and payments.
What is the role of working capital in the Cash Flow Statement under the indirect method?
-Working capital, the difference between current assets and current liabilities, affects cash flow from operating activities. Increases in current assets like inventory or receivables reduce cash flow, while increases in current liabilities like payables increase cash flow.
What are some examples of non-cash expenses that need to be added back in the Cash Flow Statement under the indirect method?
-Examples of non-cash expenses that need to be added back in the Cash Flow Statement under the indirect method include depreciation, amortization, and any gain or loss on the sale of non-current or long-term assets.
How can the movement in receivables impact cash flow from operating activities?
-An increase in receivables indicates that the company is owed more money, which reduces cash flow since it's not actual cash in hand. Conversely, a decrease in receivables suggests that more money has been collected, which would increase cash flow.
What are the main components of cash flow from financing activities?
-Cash flow from financing activitiesδΈ»θ¦ε ζ¬ a company raising capital through debt or equity, such as issuing shares or borrowing from banks, and repaying that capital, including debt repayments and dividend payouts to shareholders.
Outlines
π Introduction to Cash Flow Statement and Accounting Methods
This paragraph introduces the concept of a Cash Flow Statement, explaining its purpose as a financial document that outlines a company's cash inflows and outflows over a specific period. It contrasts the cash method and accrual method of accounting, highlighting the differences in revenue recognition and expense recording. The paragraph emphasizes the necessity of a Cash Flow Statement for businesses following IFRS or GAAP, as the accrual method does not equate the Income Statement with the Cash Flow Statement. It also mentions the importance of the Balance Sheet in accounting practices.
π Structure and Purpose of Cash Flow Statement
The paragraph delves into the structure of the Cash Flow Statement, detailing its three main sections: operating activities, investing activities, and financing activities. It explains that operating activities pertain to the core revenue generation of the business, investing activities involve the buying and selling of long-term assets, and financing activities relate to the funding of the business. The paragraph also discusses the direct and indirect methods of preparing a Cash Flow Statement, noting that while the direct method is simpler to understand, the indirect method is more commonly used due to its ease of preparation from existing financial documents.
π§Ύ Preparing Cash Flow Statement: Indirect Method
This section provides a step-by-step guide on preparing a Cash Flow Statement using the indirect method. It begins with an example of a fictional company, Tumble, and outlines the process of reconciling the net increase in cash. The paragraph explains how to calculate cash flow from operating activities by starting with net profit, adding back non-cash expenses, and adjusting for changes in working capital. It also details the cash flows from investing and financing activities, including the purchase and sale of long-term assets, as well as the raising and repayment of capital. The summary concludes with the reconciliation of the net cash increase with the movement in cash as per the Balance Sheet.
Mindmap
Keywords
π‘Cash Flow Statement
π‘Cash Method vs. Accrual Method
π‘Operating Activities
π‘Investing Activities
π‘Financing Activities
π‘Net Increase/Decrease in Cash
π‘Direct Method vs. Indirect Method
π‘Working Capital
π‘Non-cash Expenses
π‘Balance Sheet
Highlights
Cash Flow Statement is a financial statement that summarizes a business's cash inflows and outflows over a period of time.
There are two main methods for preparing books: cash method and accrual method.
Under the cash method, revenue is recognized when cash is received and expenses are recorded when cash is paid out.
In accrual accounting, revenue is recognized as it's earned and expenses are recorded as they are incurred.
Businesses using the cash method have an Income Statement equivalent to a Cash Flow Statement.
IFRS and GAAP do not allow the cash method; businesses must use the accrual method for revenue and expense recognition.
A Cash Flow Statement has three main sections: cash flow from operating activities, investing activities, and financing activities.
Operating activities are the main revenue generating activities of the business, involving cash flows from selling goods or services.
Investing activities involve buying or selling investments or other long-term assets.
Financing activities relate to funding the business through raising or repaying cash to third-party banks or the business owners.
Positive numbers in the Cash Flow Statement represent cash inflows, while negative numbers represent cash outflows.
There are two methods to create a detailed Cash Flow Statement: the direct method and the indirect method.
The direct method mirrors the Income Statement prepared under the cash method, showing cash receipts from customers and cash paid out to suppliers, employees, interest, and taxes.
The indirect method begins with the net profit or loss from the Income Statement, adds back non-cash expenses, and adjusts for the movement in working capital.
The indirect method is easier to prepare for accountants as many numbers can be found in the Income Statement and the Balance Sheet.
Tumble, a fictional dating app, serves as an example for creating a Cash Flow Statement using the indirect method.
Tumble's Cash Flow Statement reconciles with the movement in cash observed in the Balance Sheet, showing a net increase in cash of $3,105,000 during the year.
Transcripts
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