Cash Flow Statement

January 17, 2012
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Cash flow statement provides information about a firm's cash receipt and cash payments during a specific period. That is, it provides information about sources and uses of cash in the business. If you remember in our Profit and loss statement article we have mentioned that profit and loss statement is prepared on the basis of accrual accounting i.e. all incomes earned or unearned and expenses incurred or outstanding in a period are considered in preparing the statements. So to see the cash movement (i.e. actual cash received and paid) in a period we prepare the cash flow statement.

Continuing with our example

In your chocolate business whatever cash you receive from and pay in your core business operations is called the operating activity. The amount you invest in the plant; equipment is the investing activity. Furthermore if your organization invests excess cash in short-term securities or provides loans to its employees, it will come under investing activity. The funds that you have borrowed to start your business and your contribution will come under financing activity. If in future your business grows and funds are borrowed to support this growth from bond issuance or through IPO, then it will also come under the Financing activity. The Cash Flow Statement is a consolidated view of these different activities (operating, investing, financing). There are two methods for preparing the cash flow statement.

Indirect Method

Under indirect method of cash flow statement, to calculate the Cash from operating activity, we start from Net Income and adjust non-cash charges, non-operating items and changes in working capital. Cash flow from investing and financing activity are calculated in the same manner as in the direct method.

Procedure for Indirect Method

Step 1: Link the relevant profit and loss items to the Cash Flow from Operation (CFO). Net Income Gain from Sale of Land Depreciation Step 2: Link the relevant balance sheet (i.e. changes in working capital) items to the CFO Remember: Increase in assets = Outflow (-) Decrease in assets = Inflow (+) Increase in liabilities = Inflow (+) Decrease in liabilities = Outflow (-) Account Receivable Account Receivable has increased in 2011 so it is an outflow Inventory Current Liabilities Step 3: Sum all the line items in the CFO CFO Step 4: Calculate the cash from sale of land Cash from sale of land = Decrease in asset + Gain on sale of asset. Decrease in asset information you will get in Balance Sheet. Gain on sale of asset information you will get Profit and Loss Statement. Cash from Sale of Land Step 5: Calculate the purchase of Plant & Equipment (P&E) Purchases = Ending (P&E) Beginning (P&E) Plant and Equipment   Step 6: Sum the Cash from sale of land and P&E to get the Cash Flow from Investing Activity CFI Step 7: Calculate the cash from sale of Bonds Bond = Ending Bond Beginning Bond Sale of Bonds Step 8: Calculate the cash used for stock repurchase Stock repurchase = Ending Common stock Beginning Common Stock Stock Repurchase Step 9: Calculate the Cash used for dividend Cash Dividend =-Dividend Declared + Increase in Dividend Payable Cash Dividend Step 10: sum the sale of bonds, stock repurchase and cash dividend to the cash Flow from Investing Activity CFF   Step 11: calculate the Net Cash flow Net Cash flow = CFO + CFI +CFF CFO CFI CFF Net Cash Flow Step 12: Calculate the Closing Cash Balance Closing Cash Balance = Beginning Cash Balance + Net Changes in Cash Flow Closing Cash Balance Do note: This closing cash balance has to be linked back to your Balance Sheet cash balance, thus completing the Balance Sheet.  

Direct Method

Under direct method of cash flow statement, to calculate the Cash from operating activity, we start from revenue and adjust the cash received and cash paid i.e. only the cash transaction during the specific period is consider. *Under both the method cash flow from operating activity will be same only the presentation differs.

Procedure for Direct Method

Step 1: Calculate the cash collected from customer

Cash Collection = Revenue Increase in Receivables Increase in Receivables = Receivables2011 - Receivables2010 Cash Collection

Step 2: Calculate the cash paid to supplier

Cash paid to supplier = -COGS + Decrease in Inventory + Increase in Account Payable Decrease in Inventory = Inventory2011 - Inventory2010 Increase in Account Payable = A/C Payable2011 - A/C Payable 2010 Cash paid to suppliers

Step 3: Calculate the cash paid to labors (Wages)

Cash wages = - wages Decrease in wages payable Decrease in wages payable = Wages Payable2011 - Wages Payable 2010 Cash Wages

Step 4: Calculate the Cash Interest Payment

Cash Interest = -Interest Expense + Increase in Interest Payable Increase in Interest Payable = Interest Payable2011 - Interest Payable 2010 Cash Interest Paid

Step 5: Calculate the Cash Taxes Paid

Cash Taxes Paid = - Tax Expense + Increase in Taxes Payable + Increase in deferred Tax Liability Increase in Taxes Payable = TaxesPayable2011 - Taxes Payable 2010 Increase in deferred Tax Liability = Deferred Tax Liability2011 - Deferred Tax Liability 2010 Cash Taxes Paid

Step 6: Finally add all the line items calculated above to get the Cash Flow from operation (CFO)

Cash Flow from Operation

Procedure for calculating Cash Flow from Investing and Financing Activity is same as in the indirect method. Thus, we come to complete our Cash Flow Statement and the Balance Sheet as well.

Cash Flow Statement Templates to download

I have created a Cash Flow Statement template for you, where the subheadings are given and you have to link the model to get the cash numbers! You can download the same from here. You can go through the case and fill in the yellow boxes. I also recommend that you try to create this structure on your own (so that you get a hang of what information is to be recorded).

Also you can download this filled template and check, if the information you recorded, matches mine or not!


About the Author

Pankaj Baheti is a CFA Level III Candidate currently working with Pristine. Prior to Pristine, he was working with Achi Group. He has done his Post Graduate Diploma in Management and loves trekking in the hills of Arunachal.


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