This video demonstrates how to prepare a Statement of Cash Flows using the Indirect Method. A comprehensive example is provided to illustrate how an income statement, comparative balance sheet, and additional information are used to create a Statement of Cash Flows from scratch.

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How to Prepare the Statement of Cash Flows using the Indirect Method

  • The SCF tells you how and why a company’s cash balance changed over a period of time
    • The purpose of the SCF is not to determine the company’s cash balance; if you wanted to know the cash balance, you would just look at the Balance Sheet
  • The SCF has 3 sections
    • Cash Flows from Operating Activities (CFO)
      • Includes cash received for selling goods and performing services, as well as cash paid to suppliers, cash paid for interest, cash paid for taxes, etc.
    • Cash Flows from Investing Activities (CFI)
      • Includes cash paid or received for PP&E, investments, and loans made by the company to another entity
    • Cash Flows from Financing Activities (CFF)
      • Includes cash paid or received for the company’s own stock, cash paid for dividends, cash paid to repurchase debt, cash received from issuing debt
    • CFO + CFI + CFF = the change in the cash balance from the prior period
  • To calculate the information above, you need comparative Balance Sheets (this year’s and last year’s Balance Sheet), the Net Income (or Net Loss) for the period, and supplemental information (e.g., whether a fixed asset was sold for a gain or loss)
    • Calculating Cash Flows from Operating Activities is the most challenging
      • You start with Net Income (from the Income Statement)
      • Then you undo non-cash-related effects to obtain cash-basis Net Income
        • Add non-cash expenses (e.g., depreciation) back to Net Income
        • Subtract gains (e.g., on the sale of PP&E) from Net Income
        • If a non-cash current asset (e.g., Accounts Receivable) increased, subtract this from Net Income
          • There are exceptions. The purchase or sale of marketable securities classified as a short-term investment would be accounted for in the investing section (although any gain or loss would be accounted for in the operating section)
        • If a non-cash current liability (e.g., Accounts Payable) increased, add this to Net Income
      • Note: some transactions are accounted for in 2 sections
        • Eg., if your company sells a fixed asset for $55,000 cash and recognizes a $2,000 loss on the sale, the $2,000 loss would be added back to Net Income in the operating section and the $55,000 cash proceeds from the sale would be listed as a cash inflow in the investing activities section
        • Eg., cash received from borrowing money or cash paid to repurchase debt would be accounted for in the financing section, but changes in interest payable would be accounted for in the operating section