Operating Activities How do you determine cash flow provided by (used in) operat

ID: 2411043 • Letter: O

Question

Operating Activities

How do you determine cash flow provided by (used in) operating activities using the indirect method?

How is cash flow provided by (used in) operating activities determined using the direct method? How is this different from the indirect method?

Investing Activities

How do you determine cash flow provided by (used in) investing activities?

Financing Activities

How do you determine cash flow provided by (used in) financing activities?

What is the formula to calculate change in cash flow?

What are the steps to prepare the cash flow statement?

Explain the difference between the direct and indirect method.

What are some considerations that should be made when evaluating cash flow?

Explanation / Answer

Formulas used in Direct maethod for calculating OCF:

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

NOW ,

Cash received from customers xxxxxx

Cashflow from Operating Activities xxxxxxx

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

2. The direct method assumes that all sales and purchases are made on credit. Under this method, various types of cash receipts and cash payments are calculated and added to obtain the net cash flow from operating activities.

Using the indirect method, the net income figure from the income statement is used to calculate the net cash flow from operating activities. Since the income statement is prepared on an accrual basis, and there are a number of items on the income statement that affect net income but not cash flow, the earnings before interest and taxes (EBIT) must be adjusted for how much cash was actually generated by the business. To do this, noncash expenses, such as depreciation and amortization, are added back to net income. In addition, any changes to working capital, such as an increase and/or decrease in current assets and current liabilities are added to net income.

3. Cash flow from investing covers:

4. . Cash flow from financing covers:

NOW,

Add all the 3 heads of cash flows. The result appear will be Net increase or decrease in cash and cash equivalent.

5. Comparing cash flow from operating activities with EBITDA can give insights into how a company finances short-term capital. Also, investors will examine a company’s cash flow from operating activities separately from the other two components of cash flow - investing and financing activities - to determine where a company is really getting its money. Investors want to see positive cash flow because of positive income from recurring operating activities. Positive cash flow that results from the company selling off all its assets, or because it has recently issued new stocks or bonds, results in one-time gains and is not an indicator of long-term financial health.