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Proforma format for Operations

Hey there I'm James you're watching Accounting Stuff and in this video we'll go over the Cash Flow Statement for beginners a Cash Flow Statement is a financial statement that summarizes a business's cash inflows and outflows over a period of time we'll get into how that works in a moment but first why do we need a Cash Flow Statement? in accounting there are two main methods for preparing your books the cash method and the accrual method with the cash method you recognize your revenue when cash is received and you record your expenses when cash is paid out but under the accrual method you recognize revenue as it's earned and record your expenses as they are incurred so what does that mean? if you're cash accounting then technically you only have one financial statement the Income Statement it summarizes your revenues and expenses over a period of time leaving you with a profit or a loss but with the cash method we said that you recognize revenue when cash is received and you record expenses when cash is paid out that leaves you with a net cash inflow or an outflow so the Income Statement prepared under the cash method is equivalent to a Cash Flow Statement keep that in mind we'll come back to it later plenty of small businesses do their books this way which is fine but the cash method isn't allowed under IFRS or GAAP if you're following either of these then you must use the accrual method so revenue must be recognized as it's earned and expenses must be recorded as they are incurred in accrual accounting we still have the Income Statement but this time it represents what a business has earned and incurred not is cash inflows and outflows so it's not equivalent to a Cash Flow Statement so businesses using the accrual method keep a  separate Cash Flow Statement alongside their   Income Statement and they also keep a Balance Sheet which holds their assets, their liabilities and their equity not long ago i made videos covering the Income Statement and the Balance Sheet you can find links to both of those down in the description what is a Cash Flow Statement? at the start i said it summarizes a business's  cash inflows and outflows over a period of time but what does it look like? we begin with the opening cash amount at the start of the period and compare it against the closing cash amount at the end of the period you can find both of these numbers in the Balance Sheet the movement between the two is the net increase or decrease in cash and once we know that then we can get onto the real purpose of the Cash Flow Statement explaining how we ended up here there are three main sections cash flow from operating activities, cash flow from investing activities and cash flow from financing activities operating activities are the main revenue generating activities of the business these are the cash flows involved in selling goods or services investing activities sit outside of the businesses core operations they involve the buying or selling of investments  or other long-term assets and finally financing activities relate to funding the business through raising or repaying cash to third-party banks or the owners of the business this my friends is the basic structure of the Cash Flow Statement positive numbers represent cash inflows and negative numbers are cash outflows now there are a couple of ways to make a detailed Cash Flow Statement we can use the direct method or the indirect method we'll start with the direct method cash flow from operating activities under the direct method mirrors the  Income Statement prepared under the cash method which we saw earlier at the top we have cash receipts from customers which mirrors revenue and then we have the cash paid out to suppliers and employees and then interest and taxes paid collectively these mirror the businesses expenses cash flow from investing activities includes cash outflows from buying investments or other long-term assets and the cash inflows that come with selling them cash flow from financing activities relates to the raising or repaying of cash or capital there are two ways a business can do this using liabilities or equity they can borrow money from a third-party bank which would increase their liabilities or a business can look to its owners its shareholders who can make capital contributions which increase equity on the flip side they also make loan repayments back to the bank and distribute dividends back to the owners when we add up the net cash flows from operating, investing and financing activities we can reconcile the net increase or decrease in cash back to the movement in the Balance Sheet now how does the indirect method work? the only section that changes is cash flow from operating activities we use three steps to work it out the indirect method always begins with the net profit or loss from the Income Statement then in step two we add back all the non-cash expenses that appear above it these don't represent cash outflows  and they need to be reversed out the usual suspects are depreciation and amortization and any gain or loss on the sale of non-current assets or long-term assets finally we adjust for the  movement in working capital working capital is the difference between current assets and current liabilities increases in current assets like inventory or receivables reduce cash flow whereas increases in current liabilities like payables increase cash flow you can find all of these numbers on the comparative Balance Sheet now you're probably thinking that the direct method sounds a lot easier why don't we just use that? you're right it is easier to read but it's  actually harder for accountants to prepare   so we don't use it as much the indirect method is much much easier to work out because we can find a lot of these numbers in the Income Statement and the Balance Sheet as you'll see in this next example I realize that there's a lot going on here so I've put together two cheat sheets covering the direct and the indirect Cash Flow Statement I like to think of them as one page reference guides to help you out if you'd like to support the channel then you're welcome to buy them on my website the link as usual is up here and down there how do we make a Cash Flow Statement? yes it's time for that example and we'll be using the indirect method because it's easier we'll need a couple of things to get started first we need an Income Statement here's one for a business called Tumble which is a fictional dating app we actually made this one from nothing in the Income Statement video so check that out and maybe click subscribe as well it summarizes Tumble's revenues and expenses for the year ended December 31st and here's Tumble's Balance Sheet which we made in the Balance Sheet video it shows us a snapshot of their assets, liabilities and equity at the end of the year but hold on we're using the indirect method so we actually need to see last year's Balance Sheet as well so this is Tumble's comparative Balance Sheet we have the current year one on the left and last year's one on the right nice, one more thing before we begin here are some key facts which happened during the year Tumble sold some furniture for $10,000 which originally cost them $20,000 and had been depreciated by $5,000 the loss on the sale was charged to general and admin expenses Tumble also spent $910,000 on computer equipment they raised $100,000 in long-term debt and made no repayments and finally  they issued $50,000 in common stock and paid out $1,000,000 in dividends  right oh let's begin what are we reconciling? cash, this is a Cash Flow Statement after all so let's head over to Tumble's comparative Balance Sheet we can see that they held $13,895,000 in cash at the end of last year and this number increased to 17 million dollars at the end of this year so we can lift these numbers and place them at the bottom of our indirect Cash Flow Statement overall that's a net increase in cash of $3,105,000 but how did Tumble pull this off? let's find out we'll start with cash flow from operating activities in step one we need to find Tumble's net profit or loss for the current year that's easy we can get it from the Income Statement on the bottom line we can see that Tumble earned $9,650,000 this year from their core operations we'll take Tumble's net profit and put it right  at the top of cash flow from operating activities   step two we need to reverse out all of the  non-cash expenses non-cash expenses appear above the bottom line in the Income Statement some classic examples are depreciation and amortization these represent the gradual process of writing off long-term assets they aren't cash flows this year Tumble incurred $850,000 in non-cash expenses so we'll add this back in our cash flow from operating activities but that's not all Tumble made loss on the sale of long-term assets if we jump back to our key facts page we said that they sold some furniture for $10,000 so let's quickly do some workings this furniture originally cost Tumble $20,000 and by the time it was sold it had incurred $5,000 in depreciation leaving it with a carrying value of $15,000 Tumble sold this furniture for $10,000 which left them with a loss on the sale of $5,000 this is also a non-cash expense and it was charged to general and admin expenses in the Income Statement we need to reverse it out in our Cash Flow Statement so we'll add back a loss  on the sale of furniture of $5,000 step three we need to adjust for the movement in  Tumble's working capital working capital is the difference between current assets and current liabilities ignoring cash current assets are typically made up of inventory and receivables and current liabilities are payables we can find the movement in all of these on Tumble's comparative Balance Sheet it doesn't look like Tumble has any inventory but they do have some receivables  accounts receivable, other receivables and prepaid expenses which add up to $14,050,000 in the current year and $8,850,000 last year that's an increase in receivables of $5.2 million during the year an increase in receivables reduces cash flow so we subtract $5.2 million from cash flow from operating activities I like to think of it this way if receivables have gone up then Tumble is owed more money which isn't good for cash flow payables work in a similar way Tumble has accounts payable, taxes payable, accrued expenses and some deferred revenue all of this adds up to $14.4 million  in payables in the current year   and last year they had $14,850,000 in payables   that's a year-on-year decrease in payables of $450,000 we subtract decreases in payables under cash flow from operating activities because if payables go down then more supplier accounts have been settled so there's less cash when we take Tumble's profit and back their non-cash expenses and adjust for  the movement in working capital then we can see that they had a net cash inflow of $4,855,000 from operating activities a couple more things we need to do here to finish this off but first i'd like to say a big thanks to all my channel supporters you guys motivate me to keep on making more accounting tutorials if you'd like to sign up then you can click the join button next up is cashflow from investing activities  we're done with operating activities so the rest   of the Cash Flow Statement is the same whether  you're using the direct or the indirect method   on our key facts page we can see that Tumble spent  $910,000 on computer equipment this is a cash outflow from investing activities because they bought long-term assets but Tumble also sold a long-term asset remember that furniture we talked about? Tumble made a loss on its sale which we called a non-cash expense we added it back in cash flow from operating activities but we also need to record the cash receipt on the sale of $10,000 this sale isn't part of Tumble's core business so we record it as a cash flow from investing activities when we total it against the purchase of  computer equipment that leaves us with a   net cash flow from investing activities of $900,000 this time it's a cash outflow so the number's negative cash flow from financing activities financing activities involve raising or repaying cash or capital used to fund a business on the key facts page we can see that Tumble raised $100,000 in long-term debt this is a liability to a third-party bank and this year they made no debt repayments they issued $50,000 in common stock which is a capital contribution from the shareholders who own the business which increases equity and they paid $1,000,000 out in dividends back to these shareholders that would have decreased their equity we can pull all these numbers through into cash flow from financing activities Tumble received $100,000 in cash from long-term debt they raised another $50,000 in equity and they paid out $1,000,000 in dividends so that's a net cash outflow from financing activities of $850,000 almost there when we total the cash flows from operating activities, investing activities and financing activities we can see that Tumble had a net increase in cash of $3,105,000 during the year this matches the movement in cash that we saw in the Balance Sheet so we've reconciled this Cash Flow Statement using the indirect method oh yeah! hope you found that helpful let me know in the comments what you'd like to see next time bye for now