Accounting Fundamentals

Course Instructor - Scott

About Scott...
Scott is a CFI founder and the company’s Chief
Content Officer. Now based in Vancouver, Scott
spent a significant portion of his career in London,
New York, and Hong Kong. Scott has a passion for
teaching, with over 25 years of experience designing
and delivering learning solutions for firms in the
financial services sector - particularly in the areas of
commercial banking, investment banking, capital
markets, and asset management. Some of the
companies he has worked with over his career include
Bank of America Merrill Lynch, BCI, Credit Suisse,
Deutsche Bank, HSBC, ING, JP Morgan, Royal Bank of
Scott Powell Scotland, and TD Bank, to name but a few.

Chief Content Officer

Corporate Finance Institute®

Learning Objectives

Understand the role and Define various financial statement Explore the format of the income
importance of the financial terms statement, balance sheet, and
statements. cash flow statement.

Record financial statement Understand how transactions Prepare simple financial

transactions. move through the financial statements.
statements.

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Course Introduction
Understanding the Fundamentals of Accounting
Importance of Accounting and Financial Statements

Understanding accounting is crucial to

understanding finance.

This course is great for those wanting to learn or refresh

financial statements and accounting fundamentals.

Accounting gives insight into

profitability, operations, and growth.

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Importance of Accounting and Financial Statements

The Balance Sheet

Formatting and recording transactions

The Income Statement

Formatting and exploring how transactions move

The Cash Flow Statement

Building based on the balance sheet and income statement

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Importance of Accounting and Financial Statements

Watch a video lesson

Practice with exercises and

case studies

Test your knowledge

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The Language of Business

Watch a video lesson

Explore foundations
underpinning accounting
Practice with exercises and
case studies
Understand the accounting
equation
Test your knowledge

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The Language of Business
Financial statements are a method of communicating the financial health and viability of an organization to
internal and external stakeholders.

Accounting is sometimes referred to as the language of business.

Throughout the life of a corporation, the accounting processes identify,
track, and record all financial transactions.

Common accounting terms include accounts, debits, credits, journal entries,

and the general ledger.
Each of these contributes to the creation of an organization’s financial
statements.

Financial Statements are a tool used to communicate the financial performance

of all organizations and businesses.
One of the key tasks for financial analysts is the ability to review financial
statements.

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Different Types of Organizations
Organizations come in all shapes and sizes and can have a range of purposes.

Generates Generates money

revenue and earns for programs,
money for the services, or
owners. For-Profit Non-Profit or research.
Charitable

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For-Profit Organizations
For-profit businesses can be structured in three ways.

Sole Proprietorship Partnership Corporation

Owned by 1 person Owned by 2+ entities Owned by shareholders

Unlimited liability Unlimited liability Limited liability

If sued, owners are Shareholders are only at risk up to the

personally liable. amount they have invested in the shares.
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Financial Statements
The financial statements are a record of the financial activities of a business.

Income Statement Balance Sheet Statement of Cash Flows

Revenues Liabilities Operating

Assets
Expenses Investing
Equity

Profit or loss Financing

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The Accounting Equation
The accounting equation is the foundation of all accounting information.

Assets Liabilities Equity

Balance Sheet

Liabilities

Assets The balance equation must always

be true.
Equity

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The Accounting Equation

Assets Liabilities Equity

What they own What they owe What is over

• E.g., Inventory, • E.g., Long-term • I.e., Shareholder’s
equipment, loans, accounts equity
property payable
• Residual value
• Future economic • Amounts owed to
benefit vendors, suppliers,
customers, and
creditors

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The Accounting Equation

Assets Liabilities Equity

What they own What they owe What is over

1,000,000 750,000 250,000

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The Accounting Equation

Assets Liabilities Equity

What they own What they owe What is over

Issuing stock,
generating
revenues

Increasing
1,000,000 750,000 expenses,
250,000net
losses, dividends

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The Balance Sheet
Balancing the Balance Sheet
How do we make sure the balance sheet always balances?

Every accounting transaction entered

must always balance.

We use a system called double-entry

accounting (i.e., double-entry bookkeeping).

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Accounts

Debits (DR) Credits (CR) (CR) & (DR)

Assets Liabilities Equity

Cash Accounts payable Revenue CR

Accounts receivable Salaries payable Share capital CR
Prepaid insurance Unearned revenue
Inventory Notes payable Expenses DR
Capital assets Dividends DR
Vehicles
Equipment
Buildings
Land

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Recording Transactions
Let’s imagine that a company engages in the following transactions:

Issued shares for 100,000 in cash Sold all the inventory for 10,000

Took out a four-year bank loan of 50,000 Paid salaries of 1,000

Bought equipment and machinery for 80,000 Paid interest of 500

Bought inventory for 6,000

How would each of these transactions be

recorded in the accounting records?

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Issuing Shares
Let’s start by looking at what happens when a company issues shares for 100,000 in cash.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash 100,000
Non-current liabilities

Shareholder’s equity
Common stock 100,000

Non-current assets

Total 100,000 Total 100,000

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Issuing Shares
Let’s start by looking at what happens when a company issues shares for 100,000 in cash.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash 100,000 Debit Credit
Non-current liabilities
Cash 100,000
Shareholder’s equity
Shareholder’s Common stock 100,000
100,000
equity
Non-current assets

Total 100,000 Total 100,000

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Taking Out a 4-Year Bank Loan
Now let’s see what happens when the company takes out a four-year bank loan of 50,000.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [100,000 + 50,000] 150,000
100,000
73,000
Non-current liabilities
Loan payable 50,000
Shareholder’s equity
Common stock 100,000

Non-current assets

Total 150,000
100,000
153,000 Total 150,000
100,000
153,000

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Taking Out a 4-Year Bank Loan
Now let’s see what happens when the company takes out a four-year bank loan of 50,000.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [100,000 + 50,000] 150,000
100,000
73,000 Debit Credit
Non-current liabilities
Cash 50,000 Loan payable 50,000
Shareholder’s equity
Loan payable Common stock 100,000
50,000
Non-current assets

Total 150,000
100,000
153,000 Total 150,000
100,000
153,000

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Taking Out a 4-Year Bank Loan
Now let’s see what happens when the company takes out a four-year bank loan of 50,000.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [100,000 + 50,000] 150,000
100,000
73,000
Non-current liabilities
Loan payable 50,000
Shareholder’s equity
Common stock 100,000

Non-current assets

Total 150,000
100,000
153,000 Total 150,000
100,000
153,000

Corporate Finance Institute®

Taking Out a 4-Year Bank Loan
Now let’s see what happens when the company takes out a four-year bank loan of 50,000.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [100,000 + 50,000] 150,000
100,000
73,000
Non-current liabilities
Loan payable 50,000
Assets are listed in order of
Shareholder’s equity
Common stockliquidity. 100,000

Non-current assets Current assets can be

liquidated quickly and
are used in the short
term.

Total 150,000
100,000
153,000 Total 150,000
100,000
153,000

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Taking Out a 4-Year Bank Loan
Now let’s see what happens when the company takes out a four-year bank loan of 50,000.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [100,000 + 50,000] 150,000
100,000
73,000
Non-current liabilities
Loan payable 50,000
Liabilities are ordered by
Shareholder’s equity
due dates. Common stock 100,000

Current liabilities are

Non-current assets
short-term obligations
that a company must
meet within the short
term.
Total 150,000
100,000
153,000 Total 150,000
100,000
153,000

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Buying Machinery and Equipment
Let’s see what happens when a company uses its own resources to buy 80,000 of equipment.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [150,000 - 80,000] 150,000
70,000
Non-current liabilities
Loan payable 50,000
Shareholder’s equity
Common stock 100,000

Non-current assets
Equipment 80,000

Total 150,000 Total 153,000

150,000

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Buying Machinery and Equipment
Let’s see what happens when a company uses its own resources to buy 80,000 of equipment.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [150,000 - 80,000] 150,000
70,000 Debit Credit
Non-current liabilities
Equipment 80,000 Loan payable 50,000
Shareholder’s equity
Cash Common stock 100,000
80,000
Non-current assets
Equipment 80,000

Total 150,000 Total 153,000

150,000

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Buying Inventory
The next thing this company needs to do is to buy 6,000 of inventory to sell.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [70,000 - 6,000] 64,000
70,000
73,000
Non-current liabilities
Inventory 6,000 Loan payable 50,000
Shareholder’s equity
Common stock 100,000

Non-current assets
Equipment 80,000

Total 150,000 Total 153,000

150,000

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Buying Inventory
The next thing this company needs to do is to buy 6,000 of inventory to sell.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [70,000 - 6,000] 64,000
70,000
73,000 Debit Credit
Non-current liabilities
Inventory Inventory 6,000 6,000 Loan payable 50,000
Shareholder’s equity
Cash Common stock 6,000 100,000

Non-current assets
Equipment 80,000

Total 150,000 Total 153,000

150,000

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Buying Inventory
The next thing this company needs to do is to buy 6,000 of inventory to sell.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [70,000 - 6,000] 64,000
70,000
73,000
Non-current liabilities
Inventory 6,000 Loan payable 50,000
Shareholder’s equity
Common stock 100,000

Non-current assets
Equipment 80,000

Total 150,000 Total 153,000

150,000

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Adjustments and Balances

Several adjustments to our

Effect of making adjustments The company adding equity
current
related directly to the main and liabilities.
and non-current assets.
balance sheet.

We normally record transactions related to income and expenses on the income

statement, but it is important to understand how they impact the balance sheet.

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Adjustments and Balances
When we got to the equity section, you will remember we had a few different accounts that had different balances.

Equity Credit (CR)

Revenue CR
Share capital CR

Expenses DR
Dividends DR

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Selling All Inventory
Let’s see what happens when the company sells all the inventory for 10,000.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [64,000 + 10,000] 74,000
64,000
73,000
Non-current liabilities
Inventory [6,000 – 6,000] 0
6,000 Loan payable 50,000
Shareholder’s equity
Common stock 100,000
Retained earnings 4,000
Non-current assets Revenue 10,000
Equipment 80,000 Cost of goods sold (6,000)

Total shareholder’s equity 104,000

Total 150,000
160,000
154,000 Total 154,000
160,000
150,000

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Selling All Inventory
Let’s see what happens when the company sells all the inventory for 10,000.

Assets Liabilities & Shareholder’s Equity

Debit Credit
Current liabilities
Current assets
Cash [64,000 + 10,000] 74,000
64,000
73,000
Cash 10,000 on-current liabilities
Inventory [6,000 – 6,000] 0
6,000 Loan payable 50,000
Revenue 10,000
Shareholder’s equity
Common stock 100,000
Cost of Goods Retained earnings 4,000
Non-current assets 6,000 Revenue 10,000
Equipment Sold 80,000
Cost of goods sold (6,000)

Inventory 6,000
Total shareholder’s equity 104,000
Total 154,000 Total 154,000
150,000

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Paying Salaries
Next, let’s record the company’s 1,000 in salaries.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [74,000 - 1,000] 73,000
74,000
Non-current liabilities
Inventory 0 Loan payable 50,000
Shareholder’s equity
Common stock 100,000
Retained earnings 4,000
3,000
Non-current assets Revenue 10,000
Equipment 80,000 Cost of goods sold (6,000)
Salaries (1,000)

Total shareholder’s equity 104,000

103,000
Total 154,000
153,000 Total 154,000
153,000

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Paying Salaries
Next, let’s record the company’s 1,000 in salaries.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [74,000 - 1,000] 73,000
74,000 Debit Credit
Non-current liabilities
Inventory Salaries Expense 0 1,000 Loan payable 50,000
Shareholder’s equity
Cash Common stock 100,000
1,000
Retained earnings 4,000
3,000
Non-current assets Revenue 10,000
Equipment 80,000 Cost of goods sold (6,000)
Salaries (1,000)

Total shareholder’s equity 104,000

103,000
Total 154,000
153,000 Total 154,000
153,000

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Paying Interest
Finally, let’s record the 500 of interest the company accrues on the bank loan.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [73,000 – 500] 72,500
73,000
Non-current liabilities
Inventory [0] 0 Loan payable 50,000
Shareholder’s equity
Common stock 100,000
Retained earnings 2,500
3,000
Non-current assets Revenue 10,000
Equipment 80,000 Cost of goods sold (6,000)
Salaries (1,000)
Interest (500)
Total shareholder’s equity 102,500
103,000
Total 152,500
153,000 Total 152,500
153,000

Corporate Finance Institute®

Paying Interest
Finally, let’s record the 500 of interest the company accrues on the bank loan.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [73,000 – 500] 72,500
73,000 Debit Credit
Non-current liabilities
Inventory [0] Interest Expense 0 500 Loan payable 50,000
Shareholder’s equity
Cash Common stock 100,000
500
Retained earnings 2,500
3,000
Non-current assets Revenue 10,000
Equipment 80,000 Cost of goods sold (6,000)
Salaries (1,000)
Interest (500)
Total shareholder’s equity 102,500
103,000
Total 153,000
152,500 Total 153,000
152,500

Corporate Finance Institute®

Paying Interest
Finally, let’s record the 500 of interest the company accrues on the bank loan.

Assets Liabilities & Shareholder’s Equity

Current liabilities
Current assets
Cash [73,000 – 500] 73,000
72,500
Non-current liabilities
Inventory [0] 0 Loan payable 50,000
Shareholder’s equity
Common stock 100,000
Retained earnings 2,500
3,000
Non-current assets Revenue 10,000
Equipment 80,000 Cost of goods sold (6,000)
Salaries (1,000)
Interest (500)
Total shareholder’s equity 103,000
102,500
Total 152,500
153,000 Total 152,500
153,000

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The Income Statement
The Income Statement

Financial statements are a The income statement is

communication tool. broken into several
sections.

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The Income Statement
Revenue Also called Sales or Turnover

Direct operating costs

(e.g., cost of goods sold)
Gross profit

Indirect operating costs

(e.g., R&D, administration, selling,
distribution)
EBITDA
Earnings before interest, taxes,
(e.g., depreciation and amortization)
depreciation, and amortization
EBIT
Earnings before interest
Cost of debt financing
and taxes
(e.g., interest, bank charges)
EBT
Earnings before taxes
Tax
Net income
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Time and the Income Statement
The income statement and balance sheet differ in how they relate to time.

The period of time depends on the

reporting requirements for each company.

Balance Sheet Income Statement

Shows the financial Shows the results of A company’s location also impacts how
position at a point in operations over a many times they are required to report.
time. period of time.

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Matching Principle
One of the key principles that guide the recording of accounting transactions is the matching principle.

If expenses have been incurred to generate revenue, they need to be recorded on the income statement in the same period.

Regular Entries Adjusting Entries

Happens everyday Happens are the end of the period

• Entries made: • Entries capture any revenues and

expenses that may have been
• As sales are made
overstated or understated.
• Payments are received
• Prepaids, unearned revenue,
• Expenses incurred depreciation or amortization, and
• Payments are made accruals of expenses and revenues.

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Adjusting Entries – Prepayments
Insurance policies are generally paid upfront for a year or more. This is called a prepayment.

Policies expire over time.

They cannot be recorded as an expense at the time of purchase.

Record transaction as prepaid insurance.

It is an asset because there is a future economic benefit.

Debit Credit

Prepaid insurance

Cash

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Adjusting Entries – Prepayments
To demonstrate this process, let’s look at an annual insurance policy for 12,000.

Month 1… … Month 12

1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000

Debit Credit

Record a Insurance
1,000
reduction in expense
value of the
Prepaid insurance 1,000
asset

This adjusting entry has an impact on the income

statement as well as the balance sheet.

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Supplies Prepayment
Imagine that a company purchased its office supplies in bulk at certain times to ensure they always had enough to meet the
needs of the office.

Debit Credit

Supplies

Cash/Accounts Enter
payable

Debit Credit

It is not practical to track Supplies expense

the use of office supplies.
Adjust
Supplies

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Supplies Prepayment
Let’s look at an example of what happens when a company has supplies left at the end of the year.

A company buys 10,000 in supplies, so they credit cash 10,000 and

debit their supplies 10,000.

The inventory count at the end of the year indicates there are 2,000
left over.

We need to make an adjustment to the supplies account to reflect

the expenditure of 8,000 of supplies.

Debit Credit

Supplies expense 8,000

Supplies 8,000

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Adjusting Entries – Unearned Revenue
It is common for clients or customers to pay for goods or services to be delivered at a future date.

An example is putting money down as a deposit (i.e., houses, cars, event spaces, etc..)

Debit Credit

Cash

Unearned revenue
(Liability)

Debit Credit

Unearned revenue

Revenue

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Accruals
Sometimes, companies come to the end of a reporting period to realize that some of their revenue and expenses have not
been entered.

Revenue Expenses

i.e., unbilled and unfinished work i.e., telephone bills and utilities expense

The financial statements need to show the The financial statements need to show the
revenues earned in that period and the accounts expenses incurred in that period and the
receivable expected. accounts payable expected.

Debit Credit Debit Credit

Accounts Expense
receivable account
Accounts
Revenue
payable

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Adjusting Entries – Depreciation
The final adjusting entries concept to understand is depreciation.

Assets

Current assets
Cash [150,000 - 80,000] 70,000 Equipment was purchased for 80,000.

Equipment has a useful life of 4 years.

Non-current assets
Equipment 80,000

Equipment has a scrap value of 30,000.

Total 150,000

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Adjusting Entries – Depreciation
The final adjusting entries concept to understand is depreciation.

Assets

Current assets
Cash [150,000 - 80,000] 70,000

80,000 30,000

Year 1 Year 2 Year 3 Year 4

Non-current assets
Equipment 80,000

Total 150,000

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Depreciation Approaches
Depreciation is an expense and is used to reflect the decline in value of the asset over its useful life.

Straight Line Units of Production Double Declining Balance

Approach Approach Approach
30,000 30,000
30,000
25,000 25,000
25,000 25,000 25,000
25,000 (1,000)
(1,750)
(3,125) 20,000 (1,000) 20,000
20,000
(6,250)
(3,125)
15,000 (5,750)
15,000
15,000 (3,125) (4,688)
(3,125) 10,000 10,000 (3,516)
10,000
(3,125) (8,000) (2,637)
5,000 5,000 (1,978)
5,000 (3,125) (3,000) (1,483)
(1,500) (1,112) (834)
(3,125) (3,000) -
(3,125) -
-
– 1 2 3 4 5 6 7 8 – 1 2 3 4 5 6 7 8
– 1 2 3 4 5 6 7 8
Year Year
Year

All methods depend on several factors, The business needs to select the
including the cost of the asset, useful life, depreciation approach that best matches
how the asset is used, and salvage value. how the asset will be used in the business.

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Straight Line Approach
Straight line deprecation assumes that an asset will decline at a consistent rate over its lifetime.

Straight Line Depreciation

Straight Line Depreciation
Approach 30,000
25,000
25,000
20,000 (3,125)
Examples
(3,125)
15,000 (3,125)
10,000 (3,125)
(3,125)
Assets that provide the same 5,000 (3,125)
(3,125) (3,125)
level of service or production -
– 1 2 3 4 5 6 7 8
over time.
Year

Equation

Cost – Salvage value

= 25,000
Useful life of asset = = 3,125
8

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The Impact of Depreciation
Let’s go back to our example of purchasing 80,000 in equipment and calculate the depreciation expense using the straight
line approach.

Straight Line Approach

Equipment was purchased for 80,000. Cost – Salvage value

=
Useful life of asset

Equipment has a useful life of 4 years.

80,000 – 30,000
50,000
=
4
Equipment has a scrap value of 30,000. = 12,500

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The Impact of Depreciation
Let’s go back to our example of purchasing 80,000 in equipment and calculate the depreciation expense using the straight
line approach.

Straight Line Approach

Debit Credit
Equipment was purchased for 80,000. Cost – Salvage value
Depreciation 12,500 =
Useful life of asset

Accumulated
Equipment has a useful life of 4 years. 12,500
depreciation
80,000 – 30,000
=
Contra account or contra-asset account 4
Equipment has a scrap value of 30,000. (contra means against) = 12,500

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Accumulated Depreciation
Accumulated depreciation is an example of a contra-asset account.

Assets
Current assets
Cash 70,000 Year 1 Net Book
80,000 Value
Non-current assets
(12,500)
Equipment 80,000
67,500
Accumulated depreciation (12,500)

Corporate Finance Institute®

Accumulated Depreciation
Accumulated depreciation is an example of a contra-asset account.

Assets
Current assets
Cash 70,000 Year 1 Year 3
80,000 80,000
Non-current assets
(12,500) (37,500)
Equipment 80,000
67,500 42,500
Accumulated depreciation (12,500)

Assets Year 2 Year 4

80,000 80,000
Current assets
(25,000) (50,000)
Cash 70,000
55,000 30,000
Non-current assets
Equipment 80,000
Accumulated depreciation (25,000)

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Double Declining Balance Approach
This method recognizes that the business gets more value from an asset at the beginning of its useful life.

Double Declining Balance

Approach Double Declining Balance Depreciation
30,000
25,000
25,000

Examples 20,000
(6,250)
15,000
(4,688)
10,000 (3,516)
(2,637)
The asset has a higher level 5,000 (1,978)
(1,483) (1,112)
(834)
-
of depreciation at the – 1 2 3 4 5 6 7 8
beginning of its life.
Year

Equation

100%
= x2
Useful life of asset 100 %
= x 2 x 25,000 = 6,250
x Net book value 8

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Units of Production Approach
This method recognizes that the asset’s expense directly relates to its productive capacity.

Units of Production
Approach Units of Production Depreciation
30,000
25,000
25,000
(1,000)
20,000 (1,750) (1,000)
Examples
15,000 (5,750)
10,000

The more the asset is used, 5,000 (8,000)

(3,000)
(1,500) (3,000)
the higher the cost of -
– 1 2 3 4 5 6 7 8
depreciation.
Year
Lifetime units: 50,000
First year units: 2,000
Equation

# of units produced 2,000

= x (Cost – Salvage value) = x (25,000 – 0) = 4% x (25,000)
Lifetime # of units 50,000
= 1,000

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Constructing a Cash Flow Statement
The Three Key Financial Statements
Cash is an important asset. Much of a company's success depends on its ability to efficiently manage the cash flows.

Balance Sheet Statement of Cash Flows

Operating

Investing

Financing
Income Statement

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The Role of the Cash Flow Statement

Although preparing a The balance sheet does Understanding where There are many
cash flow statement is not provide any insight cash comes from and transactions that have an
not a requirement, it into how efficiently and how it has been utilized is impact on cash:
provides some very effectively cash is being very useful for both Issuing shares, borrowing
valuable information. generated and used. management and debt, revenue generation,
potential investors. purchases, debt
payments, repurchase of
outstanding shares.

Corporate Finance Institute®

Profit Versus Cash
The accrual concept recognizes revenues and costs as a business earns or incurs them, not as it receives or pays money.

It includes them in the relevant period’s income statement, and as far as possible, matches them with each other.

Income Statement Statement of Cash Flows

01. Earned 01. Received

01. Incurred 01. Paid

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Matching over Time
A five-day transit pass costs 40 and is paid in cash on Monday.

How much is the daily cost of travel Which basis better reflects the
on Thursday? cost?
• On a cash flow basis? • Of cash inflow and outflow?
• On a matching/accrual basis? • Of an individual journey?

Cash flow basis Matching/Accrual Basis Cash flow basis Matching/Accrual Basis
0, because the cash 40/5 days = 8 expense Better for planning cash Better for planning the
expense happened on per day inflows and outflows daily cost
Monday

Both approaches provide

valuable information

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Methods for Creating a Cash Flow Statement
There are two methods that can be used to create a cash flow statement, direct method, and indirect method.

VS
Direct Method Indirect Method

The direct method can be tricky and requires The indirect method talks about the impact on
much more detail which can make it more cash of management’s decisions around
time-consuming. operating, investing, and financing.

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Indirect Method
There are three main sections on the cash flow statement.

Operating Cash Flow

Operating transactions that relate directly to the generation of revenue for the
company.

Investing Cash Flow

Investing transactions include decisions around the purchase of assets that
support the operations.

Financing Cash Flow

Financing transactions are based on management’s decisions to fund business
activities (e.g., raising equity or raising debt financing).

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Working Capital
One of the trickiest parts of the cash flow statement is understanding how changes in working capital impact cash flow.

We need to look at what has changed and

determine if that indicates an increase or
decrease in cash flow.

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Changes in Working Capital

Accounts Receivable

Year 1: 46,000
Year 2: 51,000

Net cash decrease: 5,000

Accounts Receivable
Increases Decreases

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Changes in Working Capital

Inventory

Year 1: 82,250
Year 2: 78,050

Net cash increase: 4,200

Inventory
Increases Decreases

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Changes in Working Capital

Accounts Payable
Increases Decreases

Accounts Payable

Year 1: 64,580
Year 2: 65,536

Net cash increase: 956

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Changes in Working Capital

Unearned Revenue
Increases Decreases

Unearned Revenue

Year 1: 5,214
Year 2: 2,314

Net cash decrease: 2,900

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Cash From Investing
The second section of the cash flow statement is cash from investing.

In each of these cases, this investment is considered a cash

outflow.

These investments are often referred to as CAPEX, which is

short form for capital expenditures.

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How Investing Activities Hit the Three Financial Statements

Purchase

Cash Flow Balance Income

Statement Sheet Statement

Operating Cash
Non-Current Assets Operating Expense
Flow

Depreciate Investing Cash Flow

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How Investing Activities Hit the Three Financial Statements
Let’s imagine that a company has an equipment purchase in Year 1 for a company car.

Straight-Line Depreciation
Approach

Equipment was purchased for 45,500 Equation

Cost – Salvage value

=
Useful life of asset
Equipment has a useful life of 10 years

Depreciation

Equipment has a no salvage value 45,500 – 0

=
10
= 4,550 a year

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How Investing Activities Hit the Three Financial Statements
Let’s imagine that a company has an equipment purchase in Year 1 for a company car.

Income
Depreciation Expense: (4,550)
Statement

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How Investing Activities Hit the Three Financial Statements
Let’s imagine that a company has an equipment purchase in Year 1 for a company car.

Income
Depreciation Expense: (4,550)
Statement

Balance Historical Cost: 45,500

Sheet Depreciation Expense: (4,550)

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How Investing Activities Hit the Three Financial Statements
Let’s imagine that a company has an equipment purchase in Year 1 for a company car.

Income
Depreciation Expense: (4,550)
Statement

Balance Depreciation Expense: (4,550)

Sheet Historical Cost: 45,500

Cash Flow Add Back Depreciation Expense: 4,550

Statement CAPEX Cash Outflow: (45,500)

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Cash From Financing
The cash from financing section has two main areas: debt finance and equity finance.

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Cash From Financing
The cash from financing section has two main areas: debt finance and equity finance.

Debt
Borrow Repayment

Payments can be either principal payments,

interest payments, or a combination of both.
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Cash From Financing
The cash from financing section has two main areas: debt finance and equity finance.

Debt
Borrow Repayment 50,000 (50,000)

Payments can be either principal payments,

interest payments, or a combination of both.
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Cash From Financing
The cash from financing section has two main areas: debt finance and equity finance.

Equity
Issue Shares Repurchase

Pay Dividends

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Cash From Financing
The cash from financing section has two main areas: debt finance and equity finance.

Equity
Issue Shares Repurchase (5,000) (5,000)

Pay Dividends

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