 In this presentation, we will think about the thought process to know which category a cash flow should be entered into, whether it should be operating, investing, or a financing activity. When putting together the statement of cash flows, support a counting 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. We're usually going to have a worksheet, which will typically have a comparison of balance sheet accounts. We also might just have test questions that will ask us, where should this cash flow go? And that's going to be a common kind of question that we're going to have, whether we build the entire cash flow statement from scratch, or whether we're just asking test questions and trying to know what types of cash flows we're talking about. It's also important for practice as well so that we can understand when we're thinking about cash flows, where do they belong? What do these cash flows mean? What are they doing for us? What are they doing for the company? Are they part of the operations? Are they part of investing? Are they part of financing? If we look at a worksheet like this to build the statement of cash flow, typically we're going to look at a balance sheet for two periods. So here's our balance sheet for these two periods and we'll have the difference between the two periods in terms of the balance for these balance sheet accounts. So we've got cash accounts receivable, inventory, prepaid expenses. Now what we're going to do is we're going to take the change in cash. That's going to be the end result on our statement of cash flows. And we're going to kind of back into that end result by looking at the change in the other balance sheet accounts and try to figure out what's causing this change. So we're going to go through all the other balance sheet accounts, look through these changes, and we know that if we add them all up, they add up to zero. Why? Because the debits and credits for one year add up to zero. The debits and credits for the other year add up to zero. In other words, the debits minus the credits equals zero. And therefore the difference between the two years debits and credits, the change will add up to zero. So we know that's the case and we know that if we add up then everything except cash, then the result will be the difference in cash. So that's how we're going to kind of work and put together our statement of cash flows. So what we need to do then is we're going to take a look at these changes in receivables, changes in inventory, changes in prepaid expenses, and then try to determine where does that change belong before we get into any other question. Is the change of inventory and operating, investing or financing activity? And is the change in long-term notes payable? Is that going to be an operating investing or financing activity? Our goal here is to go through a thought process to see if we can think through more clearly which category these should belong to. So what's the most common journal entry in this account? It's going to be our first question. Whatever account they're giving us here, we're going to say let's think about the most common journal entry that's related to this account. There's typically going to be one or two journal entries that are going to be very common and we want to just write that down first. Once we know the most common journal entry then we're going to ask is an income statement account involved? So when we think about whatever account we're dealing with we'd write down the journal entry and say okay is there an income statement account involved? Is there a revenue account or an expense account involved? If the answer is yes then it's probably the change that we're dealing with is probably something that should be in the operating activities. Because remember the operating activities is kind of like the income statement on a cash basis. So if we're dealing with something that's this change has something to do with the income statement then it's going to be something on the operating activities typically. If the journal entry has nothing to do with the income statement there's no revenue or expense accounts involved in the normal journal entries related to these accounts then we're going to ask the question are we purchasing or selling an asset? Because so if it's not operating this means that it's not operating therefore we're trying to see if it's going to be investing activity and that typically means we're purchasing or selling an asset. If it has to do with for example property plants and equipment or some other type of investment then it's going to be an investing activity and then if it's not then it's going to be financing and of course financing is going to be dealing with notes something that we're dealing with that doesn't deal with operating activities in terms of the income statement no revenue and expenses and typically doesn't have assets involved either because what we're doing is funding the company. So that's typically going to be something that deals with cash and a subtype of liability or the equity section. So this is going to be our thought process if we go through each of those line items and think about each account on the balance sheet and then try to go through this thought process and think okay which category are we going to be putting this change to? Now this looks a little less intuitive than we might think at first glance here because note what we're doing here looking at the balance sheet accounts and we're trying to see what category these things are going to fit into and remember that the operating activities I'm keep on comparing that to the income statement and you might be thinking well these are all balance sheet accounts why do you keep mentioning the income statement and note what we're doing here is we're really kind of backing into the activity is happening by looking at the change in two points in time so we're kind of still looking at the income statement activity type of accounts we're looking at change we're looking at activity even though we're doing that by looking at the change in two points in time to balance sheet accounts which are points in time so when we look at the change in accounts receivable for example if we go through our thought process we're going to say okay accounts receivable was at $80,750 in the prior year end of the current year it's at $77,100 that means it went down by $3,650 so our our goal here is just to determine which category that change belongs to as an operating investing or financing and if we think about that then we can think well what's the normal journal entry related to accounts receivable we're going to have a debit to accounts receivable and a credit to sales that's going to be our normal journal entry that we'll have related to accounts receivable and we can see there that sales is an income statement account so we know that it is an income statement account involved we're going to say yes therefore it's an operating activity so note what we're doing here we're looking at the change in a balance sheet account we're looking at the change in the balance sheet account then ask yourself what's the normal journal entry related to this account and if we think about the normal journal entry related to accounts receivable that's a sale of something on account so accounts receivable goes up when we make a sale on account and we credit revenue and revenue is clearly an income statement account so this change then that's what we're going to think through we're going to say hmm that change looks like it belongs somewhere in the operating activities because we're dealing we're really kind of backing into sales that's what we're really looking at and we're going to do that by writing down the journal entry let's look at another account we're going to pick equipment now so we're just going to go through all these changes and we just got to find a home for all these changes when we when we make the the statement of cash flows we got to find a home for them in either operating investing or financing and we'll end up with the change in cash which is kind of like the bottom line the bottom line will be cash at the end of the day so what we're going to find a home for the equipment where's that going to go that change well if we think about the journal entry for equipment then if we buy equipment we're going to debit equipment and credit cash and possibly credit like a note payable some type of financing but if we paid cash for it this would be the most simplified journal entry even if we had a note there'd be no part of it that would be on the income statement one asset went up the other asset is going down so therefore uh is the in is an income statement account involved no so we're purchasing or we're so it's not going to be an operating activity and then the next question is are we purchasing or selling an asset in this case yeah we're purchasing an asset and that means that it's going to be an investing activity so and this was the confusing thing for me when I first started learning this thing because investing activities I had a different conception of what investing is to investing in something like any asset any anything we purchased in the business that we're not consuming now is an investment to the future in terms of of the cash flow statement we're trying to spend our cash in order to put our some our money somewhere that's going to help us make money in the future that's going to be some type of investment so in this case it's going to be an investing activity