January 17, 2012
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.
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.
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.
Step 1: Link the relevant profit and loss items to the Cash Flow from Operation (CFO).
Step 2: Link the relevant balance sheet (i.e. changes in working capital) items to the CFO
Increase in assets = Outflow (-)
Decrease in assets = Inflow (+)
Increase in liabilities = Inflow (+)
Decrease in liabilities = Outflow (-)
Account Receivable has increased in 2011 so it is an outflow
Step 3: Sum all the line items in the 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.
Step 5: Calculate the purchase of Plant & Equipment (P&E)
Purchases = Ending (P&E) Beginning (P&E)
Step 6: Sum the Cash from sale of land and P&E to get the Cash Flow from Investing Activity
Step 7: Calculate the cash from sale of Bonds
Bond = Ending Bond Beginning Bond
Step 8: Calculate the cash used for stock repurchase
Stock repurchase = Ending Common stock Beginning Common Stock
Step 9: Calculate the Cash used for dividend
Cash Dividend =-Dividend Declared + Increase in Dividend Payable
Step 10: sum the sale of bonds, stock repurchase and cash dividend to the cash Flow from Investing Activity
Step 11: calculate the Net Cash flow
Net Cash flow = CFO + CFI +CFF
Step 12: Calculate the Closing Cash Balance
Closing Cash Balance = Beginning Cash Balance + Net Changes in Cash Flow
Do note: This closing cash balance has to be linked back to your Balance Sheet cash balance, thus completing the Balance Sheet.
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
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
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
Step 4: Calculate the Cash Interest Payment
Cash Interest = -Interest Expense + Increase in Interest Payable
Increase in Interest Payable = Interest Payable2011 – Interest Payable 2010
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
Step 6: Finally add all the line items calculated above to get the Cash Flow from operation (CFO)
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.
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! 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).