Cash Flow Statement

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).

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 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.

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

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.

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! 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).