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Cash Flow from Operating Activities: Direct Method
The direct method to calculate cash flow from operating activities involves determination of various types of cash receipts and payments such as cash receipts from customers, cash paid to suppliers, cash paid for salaries, etc. and then putting them together under the cash flow from operating section of cash flow statement. These figures are calculated using the beginning and ending balances of various accounts of the business and the net increase or decrease in the account. The exact formulas to calculate various cash inflows and outflows vary. The most importan ones are given below:
Formulas
| 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 |
In the formulas given above it is assumed that accounts receivable are only used for credit sales. It is also assumed that all sales are on credit. If there are cash sales as well, then receipts from cash sales must be included in the cash receipts from customers to obtain a correct figure of cash flow from operating activities.
Similarly, it is assumed that accounts payable are used merely for purchases on account and that all purchases are on credit. If there are cash purchases as well, then cash payments for them must be included in the cash paid to suppliers. It is important to note that here may be receipts & payments other than those discussed above.
Once the all the cash inflows and outflows from operating activities are calculated, they are added in the operating section of cashflows to obtain the net cashflow from operating activities.
The following example shows the format and calculation of cash flows from operating activities using direct method.Example
Prepare the cash flows from operating activities section of cash flow statement by direct method using the following information:
| December 31 | 2011 | 2010 |
| Accounts Receivable | $34,130 | $28,410 |
| Prepaid Rent | 20,000 | 25,000 |
| Prepaid Insurance | 6,800 | 6,000 |
| Inventory | 23,030 | 15,450 |
| Accounts Payable | 14,590 | 31,300 |
| Salaries Payable | 8,310 | 5,120 |
| Interest Payable | 700 | 360 |
| Income Tax Payable | 2,340 | 0 |
| Year Ended December 31 | 2011 | |
| Net Sales | 64,970 | |
| Salaries Expense | 8,610 | |
| Rent Expense | 5,000 | |
| Insurance Expense | 3,200 | |
| Interest Expense | 1,650 |
Solution:
| Cash Flow from Operating Activities: | |
| Cash Receipts | |
| From Customers (1) | $59,250 |
| Cash Payments | |
| To Suppliers (2) | −24,290 |
| To Employees (3) | −5,420 |
| For Purchase of Prepaid Assets (4) | −4,000 |
| Interest (5) | −1,310 |
| Income Tax (6) | −0 |
| Net Cash Flow from Operating Activities | 24,230 |
| 1) 64,970 + 28,410 - 34,130 |
| 2) 23,030 - 15,450 + 31,300 - 14,590 |
| 3) 5,120 - 8,310 + 8,610 |
| 4) 20,000 + 6,800 + 5,000 + 3,200 - 25,000 - 6,000 |
| 5) 360 - 700 + 1,650 |
| 6) 0 - 2,340 + 2,340 |
Written by Irfanullah Jan
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