Let's now study the first example of the creation of the statement of cash flow. And in this example, we will analyze some transactions that the company makes starting from scratch. So that's what makes this example very simplistic. And then, we'll be able to study two major methods of creation of statement of cash flow, the so-called direct method versus the indirect method. Well, the example goes like this, this is statement of cash flow example 1. So here, we put transactions that the company makes over the period. So first, initial investment, $300. Now put like black, blue, black, blue, then the next thing is purchase of, Property plant and equipment and this is 80. The next thing, the purchase and this is a cash purchase. Purchase of inventory, And this is on credit. This is 120. Now, the fourth one is sales of goods and services. Here it goes like the sales, the amount is 210, of which cash is 140 and cost of goods sold just to keep this in mind is 100. Now the next fifth transaction is payment to suppliers, again cash, 90. Then, Other expenses, $30, but paid only $20. The next thing is depreciation charged for this period, Which is 10. And finally, we have a dividend, dividend declared, 10 but paid only 6, so these are transactions. And what we have to do, we have to create the income statement, the balance sheet, this is the easy part, we know how to do that. And the statement of the cash flow using both direct and indirect method. So what I will do, I will flip over the page, and then I will provide some of these. Well, I will use some of these numbers to come up with these things so I will not go back and forth. You can easily go back and forth for your computers, and all this clearly is on our handouts. So, we start with the simple part, so this is the income statement. Well, what do we have? We have revenues, This is 210, when we sold something, the goods and services there. Now, from here, we subtract cost of good sold, it was in the same article that is 100. Then we subtract depreciation, Which is 10. And then we subtract other expenses. Again, not paid in cash but all of them which is 30, and that gives us our net income, Of 70. Well so far so good, we are all set with the first task. Now we go to the balance sheet. Here it's a little bit more advanced, so again we have assets, Here we have liabilities and net worth. So that's what we'll put here. Well, assets, what assets are here? Cash, Accounts receivable, Inventory, and then property, plant and equipment, and then less accumulated depreciation, that's it. So cash, I will not put here first. So we have accounts receivable. The balance is, because remember, we purchased some inventories purchased on credit. But then paid something in the form of cash, so the result is accounts receivable, the balance is 70 here. Inventory, remember, it's 70 here because, I'm sorry, here we sold for 210, but received in cash only 140, the difference is 70. Inventory is 20, because we purchased 110 of inventories, and then paid 90 to suppliers. Property, plant and equipment, it was 80, but less 10 in accumulated depreciation. So that's it, cash, I will for now, put here as blank. What do we have here? We have accounts payable of 40, that's what we have to pay to our, let's see just once back. So here, we purchased on credit that was 120 minus 90, this is 30. And then this is other expenses paid only 20 so, This is now accounts payable 30 plus 10, the overall 40 and then dividend payable. Remember we declared 10 but paid only 6 so this is 4. Then capital stock, This is, 300. And now come retained earnings. And here, we have to be careful because retained earnings is what? This is net income, Less dividend declared, so that was 10, that was 70 so retained earnings is 60. Then in red, I'll put the balance. So the balance will be like this, 404 is the total. Clearly, 404 is the total here and then as a plugged number we will get 244. Now, we go to, how do we get this number? So I put that as plug but also we have to somehow calculate that. And we start with the direct method, so cash flow statement, Direct, Method. What is this? Well, we go with these transactions, 1, 2, 3, 4, 5, 6, 7, 8, and see what happens with cash. Transaction 1, when we issued capital stock, + 300. Transaction 2, purchase of property, plant and equipment,- 80. Transaction 3, did not, and we cash because we purchased that on credit. Transaction 4, when we sold, but we received cash only 140. Transaction 5, we paid to our suppliers, -90. Transaction 6, there was other expenses 30, but paid only 20. Transaction 7, depreciation, this is a noncash expense, nothing, and dividends we paid -6. And that, if we sum that all, brings us 244. This plug number that we had before, so that was the direct method. Now, let's go over the indirect method. The indirect method goes like this. You have your net income, and then you make adjustments to that. And these adjustments are the changes and balances occurring to assets. Accounts receivable, inventories, and then the current liabilities, accounts payable, and then also depreciation, because it's a noncash expense. So we sort of clause to be corrected, and then we get net cash flow from operations. Again, it's easy as seen on an example then inwards. So indirect, Method, for statement of cash flows and we start with operations. First, it's net income, this is the base, and that was 70. Now, adjustments. See how this goes, Adjustments. First of all its depreciation, because this is a noncash expense and we have to add it back, 10. Now the next goes, changes in working capital. So if this is increase in the account receivables, that means that cash goes down so we did not collect that. By the same token, increase in inventories also negative 20. But the increase in accounts payable, this is positive because that means that, we owe something but we haven't paid that yet so we keep cash. So this is 40, and therefore, net cash flow from operations, this is + 30. Now we go to in this simple example, investment and financing, they are kind of very quick. So I will use so investments. Here, this is only property, plant and equipment which is negative 80, so net cash flow investment is -80. And then finally, financing. I will use black and then red for the totals. Financing, Again simple as that, we have stock, Which is 300. And then we have dividends paid which is negative 6. So the overall net cash flow from financing is 294, and that leads us to the total. So the total change, In cash flow, total net change, it's better to say. So we combined this, so this is + 30 from operations less 80 from investing, and + 294 from financing and that brings us to the same 244. So that is about how it goes. So we can say that this procedure that seems to be cumbersome and maybe, Sort of the one that is maybe not that clear. But it's important because it breaksdown in these three areas. So you can see that in this most simplistic example, our operations are nice because we produced 30 here in cash flow. Unfortunately, we had to invest, and that is why it's negative, but that's okay. But we had massive financing, and therefore from 0, we went up to 244. And you can see that the major source or decrease for the cash flows was financing, this 300. Everything else is a smaller change. Now in the next two episodes, we will go over a more realistic situation when we would not start from scratch. We will have two balance sheets for the beginning and for the end of the period. We will not have the income statement but we will have some additional pieces of information. But we will go through these pieces and these columns in balance sheets to determine what's the net income. And what are some other important components for this indirect method for statement of cash flows. That's quite an example, and quite an exercise, if you will. But that shows to you how people normally deal with that. And that is extremely important in seeing how sometimes this indirect method is the one that really pours light on what's going on. Sometimes we have to make special calculations, sometimes we have to find some plug numbers, and without them, we'll not be able to proceed. So welcome to the next episodes.
