 The statement of cash flows is divided into three categories, operating activities, investing activities and financing activities. This video will focus on the operating activities section. There are two ways to prepare the operating activities section. The indirect method, which is preferred by industry and used by at least 95% of businesses. And the direct method, which is preferred by FASB. Regardless of which method is used, the result of the operating activities are exactly the same. This video will demonstrate the indirect method. In order to prepare a statement of cash flows, we need some financial information. Specifically, we need the current year's income statement, a comparative balance sheet, and some additional financial data. A comparative balance sheet is just a balance sheet that compares two years of data. So let's use the example of Apu's Quickie Mart. Here's the income statement that we will reference. Here's the comparative balance sheet, and you can see the years 2015 and 2016. And finally, some additional financial data. Many assignments you might encounter will provide this information to you, but I will show you how to calculate this information in case you run into a problem that doesn't present all the pertinent financial data needed. So the operating activity section of the statement of cash flow all starts with net income. We will begin with a cruel accounting net income and reconcile adjusting items to arrive at net cash from operating activities. The common adjustments are listed here on the slide. They are as follows. We add back non-cash items like depreciation expense. Depreciation expense has been deducted to arrive at net income. But since it's a non-cash expense, we want to add it back since cash wasn't reduced. We subtract gains and add back losses. Gains and losses are not the result of operating activities, but rather investing and or financing activities. So we need to cancel out their effect here in the operating activity section. Then we deduct increases in current assets and add decreases in current assets. You'll want to memorize this shortcut concept. I demonstrate why the shortcut is correct in a video called adjustments to cash flow's current assets. And finally, we add increases in current liabilities and deduct decreases in current liabilities. Again, this is a shortcut. I demonstrate why this shortcut is correct in the video called adjustments to cash flow's current liabilities. So I've listed the items that are going to be needed to complete the operating activities section in the statement of cash flows for APU's Quickie Mart. So go ahead and let's start plugging these numbers in. So the first thing we need is net income off the income statement. In this case, it's $6,100. If this company had net loss instead of net income, we can still do the statement of cash flows. We would just start with a negative number. Now we need to add back non-cash items like depreciation expense, amortization expense, and bad debt expense. The Quickie Mart has $500 of depreciation expense and no other non-cash expense. So we add $500 for depreciation expense in our adjustment section. The next thing we want to look for are gains and losses. Since gains are added to net income, we want to cancel them out of the operating activity section. We will subtract a gain of $100 in the adjustment section, thus canceling it out. We also have a loss, and losses are deductions in net income. So we will add back $200 to cancel out the effect of the loss. The next step is to look at changes in our non-cash current assets and liabilities. We skip the cash account because the change in cash is what the statement of cash flows explains. So let's start with the next current asset, which is short-term investments. These decrease by $200. So referencing your notes from earlier, we will add back decreases in current assets. So $200 is added in the adjustment section. Moving down the list, accounts receivable is next. This account increased $500. So referencing your notes from earlier, we deduct increases in current assets. So $500 is deducted in the adjustment section. Inventory is our next current asset. It increases quite a bit. While this slide is up, notice that the last current asset is prepaid insurance. Since this account had no change, it doesn't help us explain the change in cash, so we will leave it off the adjustment section. Okay, back to inventory. Since we deduct increases in current assets, $7100 is deducted in the adjustment section. For a more detailed explanation as to why we add back decreases or subtract increases in current assets, again, please see the much shorter video called adjustments to cash flows current assets. We are on to changes in our current liabilities now. Accounts payable increased $1,300. So referencing your notes from earlier, we add increases in current liabilities. So $1,300 is added to the adjustment section. Accrued liabilities is our final current liability. It decreases $100. So again, referencing your notes, we deduct decreases in current liabilities. So $100 is deducted in the adjustment section. For a more detailed explanation as to why we add back increases and subtract decreases in current liabilities, please see the much shorter video called adjustments to cash flows current liabilities. So here's what our statement of cash flows looks like after completing the operating activities section. You'll see that we have positive net cash flow from operating activities of $500, which isn't very much on $6100 of net income. Investors and creditors expect to see positive cash flows from this section. Positive cash flows from operations would be a red flag. So please watch the investing and financing activities section as well to see how this statement is completed.