Now let's apply that logic and conceptual understanding to The Garden Spot: Year One Case by preparing the statement of cash flow for their cash using the indirect method. Now notice here I have, at the bottom of our workspace I have a statement of cash flow Framework that we're going to use. Operating Activities, Investing Activities and Financing Activities and I have above that are imaginary income statement that end in the same net income, that are statement of cash flow we'll begin with. All I've done here is just set that income statement out to the side to give us more work room for the Statement of Cash Flow. Now remember the investing activity section. And the Financing Activity section of the Statement of Cash Flow prepared using the Indirect Method that is exactly like it looks under the Direct Method. We've done that work. So, I've included it here so we don't have to repeat it. Now let's go to the Operating Activities section which is where we have a lot of work to do. Now recall that the indirect method begins with net income, okay? So, we have that already here in our Statement of Cash Flow and also recall that the indirect method, what the indirect method, what we're going to do is make adjustments to net income for the difference in timing of the accrual accounting-based entries and the cash receipts and outlays for each line item on the income statement. So, we have our income statement. We'll be making adjustments for any differences between accrual accounting entries and cash receipts and outlays for each of these line items. So, let's start with line items. For the first year The Garden Spot recorded revenues of $400,000. But remember, they didn't receive $400,000 in cash from their customers. They received $315,000 in cash. But what they saw is they saw their account receivable balance increase by $85,000 [INAUDIBLE] customers [INAUDIBLE] an account. So, what that means is we need to make adjustment to net income for the change in the account receivable balance. Three on an increase and accounts receivable. That's an increase arrow right there. Increase in the accounts receivable Accounts receivable went up. So, it acts like a cash outflow because the $400,000 in revenues that leads to the net income number was not all cash. So, we got to take that none cash amount out. Let's look at the cost of good sold item. The income statement has a $240,000 cost of good sold expense. But remember I'm going to work down here below because this one get a little more complicated. Remember that the company purchased, inventory of $260,000 but it only sold 240. So, it's a we need to make and adjustment of $20,000 adjustment. Because they purchased 20, 000 more than they've actually got included in the income statement, okay? Well, guess what? That's our increase in inventory. So, 20,000 of what they bought is still sitting in inventory. So, we need to make that adjustment because it's not reflected in the cost of goods sold line on the income statement. Now, in addition to that, you might remember that of those purchases 235,000 was paid in cash. 25,000 was purchased on account. So, over 25,000 of the cash didn't go out, so that's a positive adjustment. The accounts payable balance went up that's act's like a cash in flow. So, an adjustment will need to be made for that $25,000. So that be an increase in accounts payable of $25,000, okay? So, just pause for a minute and let's think about what we've just done. We've tackled the first two lies on the income statement, revenues and cost of goods sold and we've made adjustments. Because the accrual accounting entries were a little different than the cash receipts and outlays for each of those line items. We've just made those adjustments to get this net income to be a little more cash like. All right, what about operating expenses? Well, operating expenses of 140 were all paid in cash. So, this net income number is reduced by the 140, which was all a cash payment. So, we don't have any adjustments we need to make there. The same thing with interest expense. Interest expense of 4,000 was all paid in cash at the end of the year, so the expense on the income statement is exactly equal to the cash outlay for interest. So, you don't have to make an adjustment there as well. Wage expense. You might remember that we had the employees working in December. So we recorded an expense on the income statement that matches with the revenues. But the payment wasn't going to be maintenance employees until the following January. We saw the wages payable account go up by $5,000 because the company has the liability to pay them in the following year. So here, none of this happened to be cash. It was all an increase in wages payable. The company pushed off paying the cash so it acts like a cash inflow. Depreciation expense, let's move to that one. Depreciation expense we know is a non-cash expense. That gets recorded as an expense on the income statement because we're allocating the cost of using the equipment in the truck, to the period in which it helped disgenerate revenues. We made a left hand side entry to retained earnings for depreciation expense. Right hand side entry to the truck and equipment accounts. No cash was affected with that entry. So this is a non-cash expense, so we're going to add it back. To net income, okay? So this was an expense sitting above net income, that was a non-cash expense. That income was reduced by that amount, so we better add it back in and then tax expense of 990. All of that 990 was paid in cash. So there's no adjustment that's required on the statement of cash flows and the operating activity section. So, we've proceeded to go through each line item on the income statement, and for each line item we've asked ourselves whether there's an adjustment that needs to be made due to the difference between accrual accounting and cash moving in and out. And we've made those adjustments where it was necessary. And so, now we can total our cash flow from operations. And we see that it totals a negative 6499. Here's what it looks like when it's all pretty up, when we don't look at my hand writing. And we can see it very clear.
