Cash Flow from Operations, Cost Accounting Video Lecture | Cost Accounting - B Com

in this video we're going to talk about
how to compute cash flow from operations
when you're using the indirect method to
create a statement of cash flows so
first let's understand what cash flow
from operations means so we're talking
about the net cash that's provided or
used if it's a negative number by the
firm's core business and so when we say
core business that's what we mean by
operations right so the firm we're not
talking about the investing if they're
you know buying a capital equipment or
something and they decide to sell that
capital equipment later that's not
really maybe part of their core business
that's just something they do
incidentally and and we're not talking
about financing either right so we're
not talking about raising money through
common stock so this is not investing
not financing if the money doesn't come
from those sources that we're going to
say that it comes from operations and
this this definition isn't perfect but
we're going to work with it for right
now and I'm just going to show you an
example a short example of how we go
about computing the cash flow from
operation so let's say we have a company
called healthy food industries and so
we're going to need to know a few things
in order to calculate the cash flow from
operations and we're going to need to
know net income and that's important
because the first thing we're going to
do when we calculate cash flow from
operations so just cause CFO here when
we calculate that we're going to start
with net income and then we're going to
make adjustments to it and the reason is
that when we think about money that
we're generating from operations net
income is a pretty good proxy the
problem is the net income is computed on
an accrual basis right so this has
accruals in it and what we want to do is
we want to make adjustments to the net
income to convert it more and more to a
cash basis so what we're going to have
to do is account for things like for
example depreciation expense
those are non-cash transactions right so
when we're taking depreciation expense
that's reducing our net income but that
has nothing to do with cash so we need
to know okay we have $300 in
depreciation expense and then we have a
$50 loss on the sale of some equipment
and so I'm going to explain why that's
relevant a minute but what we're also
going to need aside from
knowing these numbers from the income
statement we're also going to need to
know numbers from the balance sheets and
in particular we're going to have what's
called a comparative balance sheet so
we're gonna have balance sheet for two
different years so let's say this is the
end of year one of operations that's
what our balance sheet looks like and
then at the end of year two this is what
the balance sheet looks like and so we
compare those two snapshots of the
balance sheet of the firm's liquidity at
those points in time and we've got these
three accounts that we're going to be
looking at right now in reality a firm
will probably have a lot more accounts
than this we want to make it simple
we've got accounts receivable we've got
inventory and then we've got accounts
payable so what we're going to do is
we're going to look at the changes in
these accounts right Oh from year one to
year two and then we're going to use
those changes to actually make the
adjustments to net income so this might
be a little confusing and when I just
kind of talked about abstractly so let's
let's jump down let's let's think about
how this would go so remember we're
going to start out with net income in
our net income is that forty-seven
hundred dollars that we talked about so
let's start with that
now remember net income has accruals in
it and we want to get to cash right we
want cash flow from operations so we
need to make some adjustments here so
our first adjustment let's let's
remember that depreciation expense right
when you take depreciation expense it's
you're matching this cost right but it's
not in actual cash when you have
depreciation of three hundred dollars
that's not actually paying out three
hundred dollars right so it's an expense
but it's not cash so we're going to take
that three hundred dollars and we're
going to add it back to net income why
are we adding it and so subtracting it
we're adding it because it was deducted
to get net income right if we think
about our income statement this
depreciation expense reduced our net
income our net income would have been
five thousand dollars if we didn't have
a three hundred dollars of depreciation
expense so we're going to add this back
okay now we're going to add back this
loss this $50 loss on the sale of
equipment right so now you might be
wondering what what I don't understand
how that fits in isn't this equipment
and wouldn't that have to do with
investing well yes and let me
to explain briefly how this works so $50
loss so let's say that the Book value of
the equipment let's say the book value
was $1,000 and then our sale price so
sale price was 950 on this equipment and
let's just ignore whether the equipment
was depreciated or any of those things
for right now let's just make this
really simple let's just say that we had
a book value of $1000 and we sold it for
950 so then we have a $50 loss right on
the sale of the equipment and so the way
this works is that the $50 loss is going
to be added back the cash flow of
operate from operations because of the
fog we're going to say this 950 that we
receive that's the actual cash we
received and we're going to put that
under cash flows from investing which
I'm going to have another video on that
but it's not going to go under
operations remember investing is
different that's we're going to account
for the 950 but this $50 difference
between the 1000 and the 950 that's just
that's just we're saying we have a loss
but that really doesn't affect our cash
right the only thing affects the cash is
that we receive 950 and we're going to
account for that in the investing
section but we have this $50 loss here
of the difference between 1,000 and 950
and it reduced our net income so we're
going to add that back because that was
non-cash right we're accounting for the
cash part here and investing the $50 we
don't really want to worry about that
right that's just that's just an
accounting loss so we're going to add
that back to our net income as an
adjustment now we need to start thinking
about these accounts up here okay so now
we see that our accounts receivable we
actually had a decrease in our accounts
receivable from 625 to 550 so went down
so we had a decrease and that's actually
going to we're going to add that that 75
is going to get added so think about it
like this we had a certain amount of
receivables 625 and the receivables went
down so what does that mean all else
equal we're getting paid right the
accounts receivable our accounts that we
have were people owe us money and if
that goes down that's a good thing that
means that we're getting
so what we're going to do is we're going
to add that that decrease in accounts
receivable we're adding the $75 there
now with inventory when we look at our
inventory we're actually going up we're
going from 1100 to 1200 so we're going
to have to that's going to be what we
call a use of cash right so we think of
this 75 with the decrease in account
Street well that's a source of cash we
can think of this increase in inventory
as we're actually using cash now why you
say well why is the use of cash well
think about it
we've got 1100 of inventory and we end
up with at the end of the period of the
next period 1200 so when we think about
the net effect right I mean we might
have bought 500 of inventory or whatever
when we think about the net effect of
buying and selling inventory we went up
$100 and so we'll say that that was that
costs us $100 cash now you might be
saying well hey wait a minute sure that
that costs us $100 but how do we know it
was cash how do we know that we didn't
buy it on credit well we don't have to
worry about that right now because we're
going to worry about that when we do
accounts payable which is up next right
so when we do the inventory we just say
look we went up a hundred dollars in
inventory so increase in inventory is
going to be negative 100 and that's why
I have it in parentheses to indicate
that this is a negative number this is
actually going to be subtracted from
that 4700 it's going to be a negative
adjustment so now let's look at our
accounts payable so the accounts payable
went up $30 so we're going to have an
increase and we're going to have that as
a positive number this is not going to
be subtracted this is going to be added
in that income as an adjustment and we
think about the accounts payable this is
what we owe to other people right we owe
to our suppliers and so forth
and it went up $30 right so that means
that hey that was actually I don't wanna
say a good or bad thing but it actually
is going to be a positive 30 that we're
going to want to add right so we we
basically have this 30 was an extra
credit $3 of credit the amount of credit
that we were extended by by our
suppliers for inventory or what-have-you
that we bought actually the net effect
was it went up $30 so now we can go
and we can add up all these numbers here
okay so we start with this 4700 of our
net income and then we add the 300
depreciation we add back the loss on
sale of equipment we add the decrease in
accounts receivable 75 and then we're
going to subtract out the $100 increase
in inventory then we're going to add the
increase in accounts payable and that's
going to give us a grand total of five
thousand five thousand fifty five
dollars now we're going to call this if
you were to look at a statement of cash
flow sometimes it's different but you'll
typically see a net cash provided
provided by the operating activities now
let's say so this is a positive number
right so it means that we generated five
thousand fifty five dollars from
operations in this period okay but if we
were to think about if this were
negative which it certainly could be
negative and you might wonder hey how
could a firm possibly have negative cash
flow from operations and continue to
exist well they might be able to because
if they're generating positive positive
number from the amount of cash they get
from investing or stuff what you know
then we can have it you can have a
negative number here and you company's
still be in business right but we're not
talking about financing or investing
here we're talking about operations it's
positive but if it's negative it would
say net cash used by operating
activities
okay so provided basically just means
it's positive net cash used means that
it's negative