 In this presentation, we will continue to construct our statement of cash flows using the direct method. We have so far taken this information that's compared to balance sheet this income statement. Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it and some added information to create our worksheet. This is going to be our primary tool that we're going to use now to create the statement of cash flows. Now to do this, we're going to do this on a kind of step by step process. I'll try to explain why this is going to be the case or my argument for it at least. And so we're going to take this information and we're going to build the statement of cash flows. First, we'll just go through the steps and we want to just think of this as a kind of puzzle. We're just going to figure the thing out. We're just reconstructing the information, putting the numbers in a different order, and it's just a puzzle. So how can we fit that together? Well, we see that we have two trial balances here, the debits represented with non-bracketed or positive numbers, credits with brackets or negative numbers. And if we sum those two up, they add up to zero. So we know that this column adds up to zero. We know that this column adds up to zero or the debits minus the credits are zero. So the debits equal the credits. And then we subtracted the two columns to give us the difference of each line item. And of course, if this adds up to zero and this has up to zero, then the sum of all the differences add up to zero. So this column is really what we're going to be working with these differences. Why are we working with these differences? And you'll note this is kind of unusual because you might be thinking, well, a cash flow statement is trying to tell us what's happening over time. It needs a beginning date and an ending date that most closely corresponds to the income statement, which does the same thing on a cruel basis. But it seems like we're focusing more on the balance sheet here. And with the indirect method, we do that a lot more. So why would we be doing that? Well, we're taking two points in time and we're figuring out the difference between them, which is the activity. So we're taking two points in time and saying this is the sum of all the activity. That's the difference between these two points in time. You can also think of it, I mean, if you were to sum up all the activity from this year to this year and say, how could I get there and just in the easiest way possible or with like one journal entry, then this would kind of be the journal entry that would get you there. If you did one journal entry for the entire year, summing up of data, we wouldn't have all the detail, all the GL, but you can say, well, to get from here to there, you'd have this one giant journal entry with debits and credits. So that's the activity that's happening here. Now what we're going to do is we're just going to find a home for all these difference accounts. Now we know if we find a home for all of it, like if you look at a balance sheet, you know that something's in balance if you find a home for everything. We know that in debits and credits, the total debits equal the credits, or if we sum this up, they sum out. So on the statement of cash flows, we're really looking for this number. So we're looking for this difference number. So that's kind of like the bottom line of the statement of cash flows. And you may even want to just basically fill that out right now, just to know where we're going. So we're looking for the, in this case, increase in cash, which is going to be down here somewhere. We'll put it, I think it's right there in G18. I'm just going to say that's kind of like our bottom line. And I'm going to put it on the outer column here. It's going to go in and call them what is this I. And what I'm doing, I'm just going to pick up this number. And so we're just going to say that this equals and we'll pick up that 61,900. So there's that number. That's kind of our ending number. Once we find a home for everything else, except that number, then we'll be in balance. So this is kind of like our end goal. We can even, we can highlight that and say, you know, that's where we want to end up and possibly make that, let's make it just a light green. So that's going to be our ending number. Okay, so to do that, then we're going to find a home for everything else, because if I find a home for everything else, if we highlight everything else, other than that number, it adds up to that number. So it's just a puzzle. All we need to do is find a home for all of these other numbers. And it'll add up to that 61,900. So that's all we have to do is find a home for these numbers. We're going to do that. We could do that a couple of different ways. We could go like line by line and find each account and ask ourselves which area it goes in. Is it operating investing or financing? Or what people typically do is they go to do the operating first and then the investing and then the financing. And that makes sense too, because the operating is pretty much every most of the activity should be in operating because it's kind of like the income statement that's been flipped. And that's the activity statement. So that's what we will do here. We'll try to reconstruct the cash flows from operations. Now, when you do that, what we're really doing, you can think about it as cash flows of operations is kind of like the income statement on a cash basis. And if we scroll down here, here's the income statement. You know, sales cost gets sold, depreciation, other expenses. We can just think about how can we convert this to basically a cash flow. So we're just going to take a line by line and try to convert it. Well, sales, we're not looking for accrual sales. We're looking for the cash received. So we're just going to say, call it something different, like cash received from sales or something like that. Cash received from customers. And then we'll try to convert this number to a cash basis other than accrual basis, recognizing it when cash is received, not when we did the work necessarily, cost to get sold. Again, we can convert that to basically when did we purchase inventory, we're going to record it as the expense when we purchased it, not in a cash basis, not when we sold it, as would be the case here on an accrual basis. Depreciation, we're going to eliminate. It's not even a cash account because the journal entries debit depreciation, expense and credit accumulated depreciation, there's no cash involved. So this one is just going to be removed. We're not going to have it there. And then other expenses, we're going to have to determine again, how much of those are cash related. The loss on equipment, we're going to remove it because that is going to be something that we'll deal with in the in the any cash involved will be in the investing activities because it's on the sale of equipment. And then the income taxes, again, we just want to make sure it's on a cash basis. Well, this is income before taxes. So this is a subtotal and then income taxes. Again, we're looking to see if we actually paid them. So let's go through that. We're just going to reconstruct this in an indirect method. And remember what we would do is we would just start with net income and then we would try to reverse everything. But in this case, we're going to try to reconstruct this thing line by line. So the first line is sales. We're going to call it cash received from customers. And so then we're going to think, well, what's going to be involved in sales? And we know that this number is there. And then we got to think about, well, what's the other thing involved that's going to that's going to offset that offset the accrual because the sales are recognized when when we earned it, not when cash is received. So how can we offset that to make it just when cash is received? Well, the other side of that is going to be accounts receivable because accounts receivables in that cycle accounts receivable isn't a cruel account related to the sales cycle. So we can think through this in terms of well accounts receivable went down. So what's it going to do to the sales item? And or now that the worksheet just set up, we can also just pick it up the way it's always going to be. And that's that's going to be we're always going to basically flip the sign. So in practice in this worksheet, now that we have this set up here, everything else that we're going to go into, I'm going to use negatives instead of equals, I'm just going to say negative of the revenue minus the accounts receivable. And that's what that's it's always going to be negatives in this worksheet. That's just the way the worksheet works. Now you can think through why that works that way. Well, we know that we're kind of in a plus and minus format over here. So we don't want a negative sales. And we know that sales is an increase. And we can see that the accounts receivable went down. So what does that mean in terms of sales? That means when when accounts receivable goes down, we debit cash and we credit accounts receivable, which doesn't have to do with revenue. So it's recording cash flow, which we want to include in revenue. But it's not in revenue here because it was recorded in revenue last year. And we need to record the revenue this year. So what we did is we took this one one million one eighty five flip the sign so it's a positive number and increased it by this three thousand six fifty, because this decrease in receivables represents cash received, but for which the income was not recognized this year as we wanted to be under a cash basis, it was recognized last year. So you can think through that with every line item, I won't do it with every line item, I'm going to apply the same rule and just put a negative of this number minus this number. And then you can go through and try to think through the logic. If you think through the logic with assets and the liabilities, then you can apply that same rule to anything else. So then we're going to do the merchandise, which is our second line item here. So we found a home for the sales here. So now we're on the cost of goods sold, which is going to be basically the cat what we want to convert that to is not the cost of goods when we sold it, as it would be here, but the cash paid for inventory recording the expense when we pay for the inventory. So I'm going to go ahead and make that blue. That's what we're going to be working on. And we'll match that up with the other accounts involved in inventory, which is a little bit tricky. What else is involved in inventory? Well, we have the accounts payable typically is involved in inventory. And if the accounts payable, if the only thing we put into accounts payable is purchases of inventory, which is typically the case for like a merchandising company, then everything that goes through accounts payable is is dealing with inventory. So inventory accounts payable then would be included. So we're going to make that blue. And then the other account, of course, will be inventory. So these are all all going to be a components. Now, I'm going to think through in the same process, I'm going to use the same way to put this into the Excel worksheet, which is negative numbers. And I'm going to use kind of the same argument we had for the accounts receivable and the sales. It's a little bit more complex, of course, with the cost of goods sold, because we have the inventory, the accounts payable, and the cost of goods sold. But the theory of it is going to be the same. So I'm just going to use our same process here. Instead of hitting equals, I'm going to put negative. And then I'm going to pick up that 59,595,000 minus the accounts payable minus the inventory. And that'll give us the 6,69,150. Now, again, it's negative, of course, because it's going to be a decrease because we're paying out the cash for the inventory. So we want this to be a cash outflow because we're paying cash. And then we want to counter it against any accrual happenings here, which is going to be stuff that's in accounts payable. And you can think through that argument again on the liability side. In this case, we have the accounts payable being at 102 and going down to 17,750. So if accounts payable went down, that would mean we paid off more in cash this time period than that we had recorded the expense or we've recorded the inventory last time period. So we paid more off, we paid more cash flow this time. So you would think that this would be increasing the amount of cash payments this time. So we would think then that this number of costs to get sold is going to be probably increased by the accounts payable, the 84,250 difference here, because this represents more cash that was paid over and above what's being reported in cost of goods sold. I'm going to make these just green and blue just to match these up here. So we'll make this blue. That's where these coming from. And we'll make this one green. So they match up to what we have here. Now the next line item we have is going to be depreciation. Now, depreciation is something we're not going to include. We're just going to skip it. Why? Because there is no depreciation cash. Cash isn't a part of depreciation. The journal entries debit depreciation expense and credit accumulated depreciation. We're going to net those out. We will find a home. You might think, well, what am I going to do if I don't find a home for that? That I'm not going to be able to get to this number. We will find a home for it. But the depreciation expense you would think would net out against this number, accumulated depreciation, because the difference should be between these two accounts, debit depreciation expense and credit accumulated depreciation. And if that were the case, we can just highlight them and say we found a home and they net each other out. We don't have to deal with anything because there's nothing cash related. However, these don't net each other out. And that means that probably what happened is there's a sale of equipment and we'll deal with that in the investing activities. So because that's where we deal with that sale. So if these were the same, we can just kind of cancel them out and say we found a home and they cancel out. If they're not the same, we're going to have to deal with them in the investing activities. We'll talk about that later. So we're going to go to other expenses now and we're going to call that cash paid for other expenses. Now, of course, we grouped in some stuff here, but if we take a look at other, we're going to say, okay, here's other expenses. I'm going to make that yellow. And then we'll scroll back up and say, well, what is there anything accrual related to other expenses? And that's going to be prepaid expenses here. So this could be something like prepaid insurance. So again, this is an accrual item representing the fact that there's a difference between what we reported on the income statement and cash that was paid in this case. So we'll go through our same method. Instead of sitting equals, I'm going to put negative that'll flip the sign because this is an outflow. And then I want to put minus this and that'll subtract the two so that we took this number, flipped it to be an outflow, a negative cash flow, and then decreased it by the 1,900. Why? Because this is an asset. It went down. So we can use kind of the same logic we did with the receivable. So if if the asset went down, then that means that we consumed something in terms of the prepaid expense like the insurance, but didn't pay cash. We didn't pay cash for it, but consumed it and therefore recorded it as an expense here and recorded too much of an expense on a cash basis because on a cash basis, we didn't pay for it. And so that's why we're going to decrease it here. So I'm going to make this yellow. And again, you can go through that argument each time and try to figure it out. That's good practice. Or you can just use this method. Once you have the worksheet set up, it's always going to be the same. We're just going to say negative of negative of negative. See these formulas are negative that number, negative that number. And we just pick up and find a home for every number that way. And it'll work. Okay, so next item we have loss on sale of equipment. Again, we're not going to be dealing with that one at all. Why? It's not really cash related, it might it could be cash related, but it also it deals with equipment. So we sold the equipment. So it's going to be tangled up again with that sale of equipment, which we typically put in the investing activities. So here, we're not going to deal with it here. And you'll remember, if you remember the indirect method, that these are these two items that we had to reduce net income by, because they're not cash related, typically we would we took them out entirely by by adjusting net or increasing net income by these amounts. When we're in the direct method, we just don't include them at all, because they're not going to be part of net income. Or you can think of this equipment being part of the investing activities related to the sale of equipment. And then we've got the income taxes. And we just got to say, okay, is there an accrual up here related to income taxes? It doesn't look like any accrual taxes. So we're just going to say that this is the only line item we need on that one. And we'll make that orange, I guess, and we'll go up here and we'll say, we'll just call it cash paid for income taxes. And in this case, I'm going to say negative, as we do for all of them of that number. Because it's flipping the sign to put it into a negative format here. It will make that orange. So in this case, the cash method and accrual method are the same. We paid the same amount that we've reported as an accrual. Okay, so then we're going to say that we have the total here. So we're going to have net cash flows from operating activities. And of course, usually we're going to have inflows from operating activities, hopefully cash, more cash came into the company than left the company. But if it wasn't, we'd have to say inflows versus outflows. So in terms of the terminology that we're going to use for this bottom line item, and here on our worksheet, we've tried to kind of avoid the terminology, we didn't say inflow or outflow, we just said net cash flows to kind of put together generic worksheets that we can build the cash flow statement so that the worksheet should help us to do that. And then we can go in and change the terminology if we so choose. So now we're just going to sum these up. So we're going to say this minus this minus this minus this. Here's the inflows kind of like revenue on a cash basis minus the expenses kind of on a cash basis. So and that'll and that's going to give us the net cash flows from operating activities. So we'll do that with the sum function equals the sum. We're just going to highlight then or just click the sum function and highlight the 1888 down to the 650 down to the 28 350. And that'll give us the 130 200. This should match what is on the cash flow statement under the indirect method. So these should be the same. So when we go through the second components, we should basically be doing the same thing. We'll construct it the rest of it from our worksheet over here so we can see the full process under direct method. But note that the we should get to the same result for the cash flows from investing activities and financing activities. Those don't differ between the two methods. The thing that differs is the cash flow from operating act operating activities. But we want to basically go through the full process again. So we can see the fact that if we find a home for all this stuff, it works no matter what method we're using.