Understanding Cash Flows from Operating Activities

Steps in Calculating Operating Cash Flows (Indirect Method)

1. Operating profit before working capital changes
2. Cash generated from operations
3. Income tax paid
4. Net cash flow from operating activities
5. Goodwill amortised

1. Start with the profit before tax (derived from the profit after tax by adding back tax expense).
2. Adjust for non-cash expenses and non-operating items debited or credited to the profit and loss account. Goodwill amortised is a non-cash expense that needs to be added back.
3. This leads to the operating profit before working capital changes.
4. Adjust for changes in working capital items (current assets and current liabilities).
5. This gives the cash generated from operations.
6. Subtract income tax paid.
7. The result is the net cash flow from operating activities.

1. The process begins by adjusting the profit for non-cash items. Goodwill amortised (E) is a non-cash expense, so it is one of the initial adjustments made to arrive at operational profit before working capital changes.
2. After making adjustments for non-cash and non-operating items, we arrive at the Operating profit before working capital changes (A).
3. Next, we adjust for changes in working capital (increase/decrease in current assets and current liabilities). This adjustment leads to the figure for Cash generated from operations (B).
4. From the cash generated from operations, we subtract the Income tax paid (C) during the period.
5. Finally, after accounting for taxes (and possibly extraordinary items if any), we arrive at the Net cash flow from operating activities (D).

Step-by-Step Sequence Analysis

1. (E) Goodwill amortised: This is a non-cash expense added back to net profit to get to operating profit before working capital changes. It comes early in the calculation.
2. (A) Operating profit before working capital changes: This figure is reached after adjusting net profit for non-cash and non-operating items.
3. (B) Cash generated from operations: This is the amount of cash generated from core operations *before* accounting for income tax paid. It is calculated by adjusting operating profit before working capital changes for changes in working capital.
4. (C) Income tax paid: The actual cash outflow for income tax is deducted from the cash generated from operations.
5. (D) Net cash flow from operating activities: This is the final figure representing the total cash inflow or outflow from operating activities after all adjustments and tax payments.

Revision Table: Cash Flow from Operating Activities Sequence

Additional Information: Key Concepts in Operating Cash Flow

Calculating cash flow from operating activities helps users understand the cash-generating ability of a company's core business. Here are some related concepts:

• Non-cash expenses: These are expenses recognised in the income statement that do not involve a cash outflow in the current period, such as depreciation, amortisation (like goodwill amortisation), and provisions. These are added back to net profit when using the indirect method.
• Working Capital Changes: Changes in current assets (excluding cash) and current liabilities (excluding short-term borrowings and bank overdrafts) impact operating cash flow. An increase in current assets (like receivables or inventory) typically reduces cash flow, while a decrease increases it. Conversely, an increase in current liabilities (like payables) increases cash flow, while a decrease reduces it.
• Cash Generated from Operations: This is the cash flow before accounting for interest received or paid (if classified as operating) and income taxes paid. It shows the cash derived purely from the core business operations after accounting for working capital movements but before financing costs and taxes.
• Income Tax Paid: This represents the actual cash outflow for corporate income taxes during the period. It is deducted to arrive at the final net cash flow from operating activities.