Thursday, 9 August 2012

Cash Flow from operating activities-direct method

                The cash flow from investing activities and financing activities are both found out by finding the actual cash flows from the various ledgers directly. This is the same under both direct and indirect methods

Cash flow from operating activities

        Cash flow in this section under direct method is found out by collating the actual cash flow form various journals and deriving at, directly from the balance sheets, income statements and T accounts(ledgers). This is unlike the indirect method, in which, various non cash expenses, incomes, gains losses, are reversed from the net income, and various cash out flows and inflows  which do not comprise in the net income figure ( like cash received and payed for receivables and payable ), are added back to the net income, to arrive at the cash flow from operating activities.

              Cash receipts from operations include cash received from customers for goods and services, cash interest and dividends, and other operating receipts if any. Cash payments include cash paid to employees and suppliers of goods and services, cash interest and income tax payments, and other operating payments if any. We must search through the accounts to find these cash receipts and payments.

Sales and purchase

1. Cash inflows from direct cash sale and purchases are found out directly from the various cash journals.

 2. Cash payments received after the sales is found out  as given below

  Change in accounts receivable for sales = sales on account in that period-cash received after sales

3. Cash payments payed after purchase is found out as given below

 Change in accounts payable for purchase=purchase on account in that period - cash payed after purchase

4. Change in accounts payable/receivable for purchase/ sales, sales on account are found out from the various ledgers. Purchase on account can be derived directly from change in merchandise inventory and COGS if we assume that all purchases are on account.

5. If we assume all the purchase/sales are on account and the accounts receivable/purchases are only for sales and purchases, then we can find out the cash received/ payed after sale/purchases directly from the consecutive balance sheets and the income statement.

Accrued Liabilities( Wages, Salary, tax, interest)

Consider the following common transactions

Interest expense             5000
Interest  payable                                    5000

Cash                                                     2000
Interest payable              2000

Here the cash out flow can be calculated as follows

Change in accrued liability = expense-cash

Prepaid expenses ( Rent, supplies, insurance)

Rent                               10000
Cash                                                 10000

Rent expense                  2000
Rent                                                  2000

All the pre paid expense are paid totally with cash ( no point in being pre paid if there is any payable)

The cash out flow for pre paid expenses can be calculated as follows.

Change in prepaid expense = cash- expirations


Cash flow from operating activities can be calculated from the various methods as described above. The idea
is to find the cash flow directly, than deducing from the net income figure, as in the indirect method.


No comments:

Post a Comment