Cash Flow from Operating Activities Preparation & Example

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Cash flow from operating activities is the most important part of the cash flow statement. This part shows that whether and to what extent the business has generated cash from its main operations. The cash generated from operations as shown by this part of the cash flow statement is later on used to pay against other activities of the business. In other words, business needs cash to pay its debts such as bank loans, account payable etc. and for these payments to be made, business must generate sufficient cash from its operations. That’s why this portion of the cash flow statements has always been the main focusing point for the owners.

The components of operating activities mostly include those items which determine the profit or loss of an enterprise. Therefore, in words we would say that items to be shown under cash flow operating activities refer to those activities which relate to revenue generation of the enterprise. In accordance with International Accounting Standard of cash flow statement, the following activities or cash flows shall be the part of operating activities. 

  1. Cash receipts from sales of goods or services
  2. Cash receipts from other income such as royalties, commissions etc
  3. Cash paid to suppliers for goods and services
  4. Cash paid to entity’s employees
  5. Cash paid on behalf of entity’s employees
  6. Cash receipts and payments from contracts held for dealing purposes

This is very essential to keep in mind that there are certain items which may be included in the net profit for the year but actually do not form the part of operating activities. Examples include disposal income or loss. Such items are excluded from operating activities and shown under investing or financing activities accordingly.

Similarly, net profit for the year as reported in the cash flow statement may include certain items of income or expense which do not represent an actual cash inflow or outflow. These items are called non-cash items and may include, but not limited to, depreciation, amortization etc. Appropriate adjustments are made in the cash flow statement for these non-cash items so as to reach to the figure of profit representing actual cash position.

Example and Preparation

To understand the operating cash flow activities, consider the following example. The following are the changes in balance sheet of A Traders for year ended December 31, 2015.

Account Heads
Debit 
Credit
Cash
1,000
 
Accounts Receivables
15,800
 
Inventories
10,000
 
Goodwill
 
12,000
Building
35,000
 
Machinery
4,000
 
Equipment
1,500
 
Allowance for depreciation (Building & Machinery)
 
1,400
Allowance for depreciation (equipment)
 
1,500
Discount on issuance of debentures
1,200
 
Accounts Payable
 
2,000
Debentures
 
44,600
Preferred Shared
6,000
 
Ordinary Shares
 
8,000
Premium on ordinary shares
 
2,000
Retained earnings
 
3,000
 
74,500
74,500

Addtional information

  1. Disposal of part of building

Book value$ 20,000

Sales proceeds$ 22,000

  1. Preference shares were redeemed              $   7,500
  2. Interim dividend paid                                 $   8,000
  3. Goodwill written off against retained earnings
  4. Exchange of machinery:

Old machinery cost$ 4,000

Acc: depreciation$ 1,000

New machinery cost$ 8,000

Cash paid$ 5,000

From the above given data students will learn to prepare cash flow from operating activities using indirect method.

CASH FLOW FROM OPERATING ACTIVITIES
$
$
Net profit before taxation
24,500
 
Adjustments for: 
 
 
Depreciation
7,400
 
Disposal loss
-2,000
 
Operating profit before working capital changes
 
29,900
Increase (decrease) in Currrent Assets
 
 
Decrease in Accounts Receivable
-15,800
 
Decrease in inventories 
-10,000
 
Increase (decrease) in Currrent Liabilities
 
 
Decrease in payables 
2,000
 
Net cash flow from operating activities 
 
6,100

Working on Net Profit before Taxation and Depreciation 

Cash Flow Operating Activities Working Tax depreciation