Download Net Cash Flow from Operating Activities

Statement of Cash Flows / Cash Flow
Statement
A statement of cash flows is a financial statement which summarizes cash transactions of a
business during a given accounting period and classifies them under three heads, namely, cash
flows from operating, investing and financing activities. It shows how cash moved during the
period by indicating whether a particular line item is a cash in-flow or a cash out-flow. The term
cash as used in the statement of cash flows refers to both cash and cash equivalents. Cash flow
statement provides relevant information in assessing a company's liquidity, quality of earnings
and solvency.
Sections
As stated above, a statement of cash flows comprises of three sections:
1. Cash Flows from Operating Activities
This section includes cash flows from the principal revenue generation activities such as
sale and purchase of goods and services. Cash flows from operating activities can be
computed using two methods. One is the Direct Method and the other Indirect Method.
2. Cash Flows from Investing Activities
Cash flows from investing activities are cash in-flows and out-flows related to activities
that are intended to generate income and cash flows in future. This includes cash in-flows
and out-flows from sale and purchase of long-term assets.
3. Cash Flows from Financing Activities
Cash flows from financing activities are the cash flows related to transactions with
stockholders and creditors such as issuance of share capital, purchase of treasury stock,
dividend payments etc.
Importance Of Cash Flow Statement
The cash flow statement provides information regarding inflows and outflows of cash of a firm for a
period of one year. Therefore cash flow statement is important on the following grounds.
1.Cash flow statement helps to identify the sources from where cash inflows have arisen within a
particular period and also shows the various activities where in the cash was utilized.
2. Cash flow statement is significant to management for proper cash planning and maintaining a proper
matching
between
cash
inflows
and
outflows.
3. Cash flow statement shows efficiency of a firm in generating cash inflows from its regular operations.
4.Cash flow statement reports the amount of cash used during the period in various long-term investing
activities, such as purchase of fixed assets.
5. Cash flow statement reports the amount of cash received during the period through various financing
activities,
such
as
issue
of
shares,
debentures
and
raising
long-term
loan.
6. Cash flow statement helps for appraisal of various capital investment programmes to determine their
profitability and viability.
Cash Flow from Operating Activities Indirect Method
The first section of a cash flow statement, known as cash flow from operating activities, can be
prepared using two different methods known as the direct method and the indirect method. Here
we will study the indirect method to calculate cash flows from operating activities.
In indirect method, the net income figure from the income statement is used to calculate the
amount of net cash flow from operating activities. Since the income statement is prepared on
accrual basis in which revenue is recognized when earned and not when received therefore net
income does not represent the net cash flow from operating activities and it is necessary to adjust
earnings before interest and tax (EBIT) for those items which effect net income although no
actual cash is paid or received against them.
Formula
The following is the indirect method formula to calculate net cash flow from operating activities:
Cash Flows from Operating Activities:
Net Income
+ Non-Cash Expenses:
(Depreciation, Depletion & Amortization Expense)
+ Non-Operating Losses:
(Loss on Sale of Non-Current Assets)
− Non-Operating Gains:
(Gain on Sale of Non-Current Assets)
+ Decrease in Current Assets:
(Accounts Receivable, Prepaid Expenses, Inventory etc.)
− Increase in Current Assets
+ Increase in Current Liabilities:
(Accounts Payable, Accrued Liabilities, Income Tax Payable etc.)
− Decrease in Current Liabilities
Net Cash Flow from Operating Activities
Cash Flow from Operating Activities: Direct Method
The direct method to calculate cash flow from operating activities involves determination of
various types of cash receipts and payments such as cash receipts from customers, cash paid to
suppliers, cash paid for salaries, etc. and then putting them together under the cash flow from
operating section of cash flow statement. These figures are calculated using the beginning and
ending balances of various accounts of the business and the net increase or decrease in the
account. The exact formulas to calculate various cash inflows and outflows vary. The most
importan ones are given below:
Formulas
Cash Receipts from Customers =
+ Net Sales
+ Beginning Accounts Receivable
= − Ending Accounts Receivable
Cash Payments to Suppliers =
+ Purchases
+ Ending Inventory
− Beginning Inventory
+ Beginning Accounts Payable
− Ending Accounts Payable
Cash Payments to Employees =
+ Beginning Salaries Payable
− Ending Salaries Payable
+ Salaries Expense
Cash Payments for Purchase of Prepaid Assets =
+ Ending Prepaid Rent, Prepaid Insurance etc.
+ Expired Rent, Expired Insurance etc.
− Beginning Prepaid Rent, Prepaid Insurance etc.
Interest Payments =
+ Beginning Interest Payable
− Ending Interest Payable
+ Interest Expense
Income Tax Payments =
+ Beginning Income Tax Payable
− Ending Income Tax Payable
+ Income Tax Expense
In the formulas given above it is assumed that accounts receivable are only used for credit
sales. It is also assumed that all sales are on credit. If there are cash sales as well, then receipts
from cash sales must be included in the cash receipts from customers to obtain a correct figure
of cash flow from operating activities.
Similarly, it is assumed that accounts payable are used merely for purchases on account and
that all purchases are on credit. If there are cash purchases as well, then cash payments for
them must be included in the cash paid to suppliers. It is important to note that here may be
receipts & payments other than those discussed above.
Once the all the cash inflows and outflows from operating activities are calculated, they are
added in the operating section of cashflows to obtain the net cashflow from operating
activities.
The following example shows the format and calculation of cash flows from operating
activities using direct method.
Example
Prepare the cash flows from operating activities section of cash flow statement by direct
method using the following information:
December 31
Accounts Receivable
Prepaid Rent
Prepaid Insurance
Inventory
Accounts Payable
2011
2010
$34,130 $28,410
20,000 25,000
6,800 6,000
23,030 15,450
14,590 31,300
Salaries Payable
Interest Payable
Income Tax Payable
8,310
700
2,340
5,120
360
0
Year Ended December 31 2011
Net Sales
64,970
Salaries Expense
8,610
Rent Expense
5,000
Insurance Expense
3,200
Interest Expense
1,650
Solution:
Cash Flow from Operating Activities:
Cash Receipts
From Customers (1)
$59,250
Cash Payments
To Suppliers (2)
−24,290
To Employees (3)
−5,420
For Purchase of Prepaid Assets (4)
−4,000
Interest (5)
−1,310
Income Tax (6)
−0
Net Cash Flow from Operating Activities 24,230
Working Notes
1) 64,970 + 28,410 - 34,130
2) 23,030 - 15,450 + 31,300 - 14,590
3) 5,120 - 8,310 + 8,610
4) 20,000 + 6,800 + 5,000 + 3,200 - 25,000 - 6,000
5) 360 - 700 + 1,650
6) 0 - 2,340 + 2,340
Cash Flows From Investing Activities
Cash flows from investing activities is the second section of a statement of cash flows which
details cash flows related to acquisition and disposal of a company's long-term investments
such as property, plant and equipment, investment in subsidiaries and associates, etc.
Cash flows from investing activities is separately reported because it tells the users of the
financial statements whether the company is investing in resources that are expected to result
in increased profits in future periods or whether it is disposing out resources already owned.
Following are cash flows that are typically reported as cash flows from investing activities:
1. Cash payments to acquire or construct long-term fixed assets such as plant and
machinery, vehicles, equipment, etc.
2. Cash receipts from sale of PPE and intangible assets such as buildings, copyrights, etc.
3. Cash payments to purchase bonds or shares of other companies (subsidiaries, associates
and joint ventures).
4. Cash receipts from sale of bonds and shares of other companies.
5. Cash payments in the form of loans and advances and receipt related to payback of
such loans and receivables, etc.
In general, US GAAP and IFRS converge on classification of cash flows from investing
activities. However, there are some exceptions: IFRS allows dividend income earned on
investment in shares and interest earned on loans and advances to other parties to be classified
as either an inflow from operating activities or an inflow from investing activities while US
GAAP requires it to be reported under the cash flows from operating activities only.
Cash Flows From Financing Activities
Cash flows from financing activities is the last of the three sections of a statement of cash
flows. It shows the cash inflows and outflows related to transactions with the providers of
finance i.e. the owners and the creditors of the company. Thus, cash flows from financing
activities include the following basic components:




Proceeds from borrowings (both shot-term and long-term)
Cash received from owners usually on issuance of stock
Repayments of borrowings
Repayments to owners
However certain items are classified differently by different accounting standards. For
example, under IFRS, interest payments and dividend payments are classified either as cash
flows from operating activities or cash flows from financing activities. Under US GAAP
interest payments can only be classified as cash flows from operating activities and dividends
can only be classified as cash flows from financing activities.
Example
Cash Flows from Financing Activities
Loan Obtained
Issuance of Common Stock
Treasury Stock Purchased
Dividends Paid
$20,000
125,000
− 32,000
− 10,000
Net Cash Flow from Financing Activities
$103,000
Cash Flow Statement Indirect Method
The statement of cash flows is one of the components of a company's set of
financial statements, and is used to reveal the sources and uses of cash by a
business.
Under the indirect method of presenting the statement of cash flows, the
presentation begins with net income or loss, with subsequent additions to or
deductions from that amount for non-cash revenue and expense items, resulting in
net income provided by operating activities.
The format of the indirect method appears in the following example. In the
presentation format, cash flows are divided into the following general
classifications:



Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
The indirect method of presentation is very popular, because the information
required for it is relatively easily assembled from the accounts that a business
normally maintains in its chart of accounts. The indirect method is less favored by
the standard-setting bodies, since it does not give a clear view of how cash flows
through a business (as is shown under the direct method of presentation).
Statement of Cash Flows Indirect Method Example
For example, Lowry Locomotion constructs the following statement of cash flows
using the indirect method:
Lowry Locomotion
Statement of Cash Flows
for the year ended 12/31x1
Cash flows from operating activities
Net income
$3,000,000
Adjustments for:
Depreciation and amortization
Provision for losses on accounts receivable
Gain on sale of facility
$125,000
20,000
(65,000)
80,000
Increase in trade receivables
(250,000)
Decrease in inventories
325,000
Decrease in trade payables
(50,000)
25,000
Cash generated from operations
3,105,000
Cash flows from investing activities
Purchase of property, plant, and equipment
Proceeds from sale of equipment
(500,000)
35,000
Net cash used in investing activities
(465,000)
Cash flows from financing activities
Proceeds from issue of common stock
150,000
Proceeds from issuance of long-term debt
175,000
Dividends paid
(45,000)
Net cash used in financing activities
280,000
Net increase in cash and cash equivalents
2,920,000
Cash and cash equivalents at beginning of period
2,080,000
Cash and cash equivalents at end of period
$5,000,000
Cash Flow Statement Direct Method
The direct method of presenting the statement of cash flows presents the specific
cash flows associated with items that affect cash flow. Items that typically do so
include:






Cash collected from customers
Interest and dividends received
Cash paid to employees
Cash paid to suppliers
Interest paid
Income taxes paid
The advantage of the direct method over the indirect method is that it reveals
operating cash receipts and payments.
The standard-setting bodies encourage the use of the direct method, but it is rarely
used, for the excellent reason that the information in it is difficult to assemble;
companies simply do not collect and store information in the manner required for
this format. Using the direct method may require that the chart of accounts be
restructured in order to collect different types of information. Instead, they use the
indirect method, which can be more easily derived from existing accounting reports.
Statement of Cash Flows Direct Method Example
Lowry Locomotion constructs the following statement of cash flows using the direct
method:
Lowry Locomotion
Statement of Cash Flows
for the year ended 12/31/x1
Cash flows from operating activities
Cash receipts from customers
$45,800,000
Cash paid to suppliers
(29,800,000)
Cash paid to employees
(11,200,000)
Cash generated from operations
4,800,000
Interest paid
(310,000)
Income taxes paid
(1,700,000)
Net cash from operating activities
$2,790,000
Cash flows from investing activities
Purchase of property, plant, and equipment
Proceeds from sale of equipment
Net cash used in investing activities
(580,000)
110,000
(470,000)
Cash flows from financing activities
Proceeds from issuance of common stock
1,000,000
Proceeds from issuance of long-term debt
500,000
Principal payments under capital lease obligation
(10,000)
Dividends paid
(450,000)
Net cash used in financing activities
1,040,000
Net increase in cash and cash equivalents
3,360,000
Cash and cash equivalents at beginning of period
1,640,000
Cash and cash equivalents at end of period
$5,000,000
Reconciliation of net income to net cash provided by operating activities:
Net income
$2,665,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization
Provision for losses on accounts receivable
$125,000
15,000
Gain on sale of equipment
(155,000)
Increase in interest and income taxes payable
32,000
Increase in deferred taxes
90,000
Increase in other liabilities
18,000
Total adjustments
Net cash provided by operating activities
125,000
$2,790,000