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Business Money

Cash Flow Statements

A cash flow statement (or statement of cash flows) shows a fairly detailed description of the movement (or flow) of cash over a period of time. The cash flow statement includes with the cash flows from operating activities, investing activities, financing activities and provides the cash and equivalents total for the end of the reported period.

There are two methods of measuring the cash flows from operating activities

Direct Method

This is the simplest, yet the least used method. The requirements are simply to add up all the payments and receipts over the reported period to give a total that reflects on the cash flow statement.

Indirect Method

This method is the more popular method and is based on the principal that the sales revenue increases cash inflow while expenses increases cash outflows. “The indirect method adjusts net income for items that affected reported net income but didn’t affect cash” (Anon, n.d.)

Examples

ABC Limited reported a revenue of $ 1 000 000 at the year ending 31 December 2010. The income statement reflected a $ 140 000 tax payment and a Net Income of $ 34 000. Accounts receivable increased by $ 200 000; therefore cash collected on the revenue is $ 800 000 ($ 1 000 000 – $ 200 000). ABC Limited reported operating expenses of $ 825 000. Accounts payable (operating expenses) was reported as being $ 45 000; therefore cash operating expenses were $ 780 000 ($ 825 000 – $ 45 000). Tax payable at the end of the year was reflected as $ 0.00 which means the income tax payment was made during the year in cash.

Direct Method

Cash collected from revenues                                                   800 000
Cash payments for expenses                                                     780 000
Income before income taxes                                                            20 000
Cash payments for income taxes                                            140 000
Net cash flow from operating activities                                     (120 000)

Indirect Method

Net income                                                                                           35 000
Increase in accounts receivable                                         (200 000)
Increase in accounts payable                                              45 000         (155 000)
Net cash flow from operating activities                                    (120 000)

We can see that both methods result in the same net cash from operating activities. While direct looks directly at the cash in hand the indirect looks more at the income statement and uses trade payables and receivables to work out the cash flow from operating activities.

References

Anon (n.d.) Cash Flow Statement Example-Direct and Indirect Method [Online] Accounting for Management. Available from: http://www.accountingformanagement.com/preparation_of_statement_of_cash_flows.htm (Accessed: 16 April 2010).

Atrill, P. & McLaney, E. (2008) Accounting and Finance for Non-Specialists. 6th Edition. Financial Times Press.

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