If net profit made during the year are ₹50,000 and the bills receivables have decreased by ₹10,000 during the year then the cash flow from operating activities will be:
₹60,000
Understanding Cash Flow from Operating Activities
Calculating cash flow from operating activities is a crucial part of preparing a cash flow statement. It shows how much cash a company generates from its core business operations. One common method for this calculation is the indirect method, which starts with net profit and adjusts it for non-cash items and changes in working capital components like bills receivables.
Indirect Method for Operating Cash Flow
The indirect method begins with the net profit reported in the income statement. Since net profit includes non-cash expenses (like depreciation) and is calculated using accrual accounting (recognizing revenue/expenses when earned/incurred, not necessarily when cash is received/paid), adjustments are needed to arrive at the actual cash flow. Changes in current assets and current liabilities (which make up working capital) significantly impact cash flow from operations.
Impact of Changes in Bills Receivables on Cash Flow
Bills receivables represent amounts owed to the company by customers for goods or services delivered. They are considered a current asset. When bills receivables decrease during a period, it means the company has collected cash from customers for amounts that were previously outstanding. This collection of cash increases the cash inflow from operations.
- An increase in bills receivables means more credit sales were made than cash collected, tying up cash. This is subtracted from net profit.
- A decrease in bills receivables means more cash was collected from debtors than new credit sales were made, releasing cash. This is added back to net profit.
Step-by-Step Calculation of Operating Cash Flow
To calculate the cash flow from operating activities based on the provided information, we start with the net profit and adjust for the change in bills receivables.
Given information:
- Net Profit made during the year: ₹50,000
- Decrease in Bills Receivables during the year: ₹10,000
Calculation:
Cash Flow from Operating Activities = Net Profit + Adjustment for decrease in Bills Receivables
Cash Flow from Operating Activities = ₹50,000 + ₹10,000
Cash Flow from Operating Activities = ₹60,000
Therefore, the cash flow from operating activities is ₹60,000.
Summary of Cash Flow Calculation
Let's summarize the calculation in a simple table:
| Item | Amount (₹) | Adjustment |
|---|---|---|
| Net Profit | 50,000 | Starting Point |
| Decrease in Bills Receivables | 10,000 | Add back (Cash Inflow) |
| Cash Flow from Operating Activities | 60,000 |
Revision Table: Operating Cash Flow Adjustments
| Working Capital Item | Change | Adjustment to Net Profit (Indirect Method) |
|---|---|---|
| Current Asset (e.g., Bills Receivables) | Increase | Subtract |
| Current Asset (e.g., Bills Receivables) | Decrease | Add Back |
| Current Liability (e.g., Bills Payable) | Increase | Add Back |
| Current Liability (e.g., Bills Payable) | Decrease | Subtract |
Additional Information on Operating Cash Flow
The cash flow statement is divided into three main sections: operating activities, investing activities, and financing activities. Cash flow from operating activities is usually the most significant as it reflects the cash generated or used by the core business operations. Understanding these adjustments is key to analyzing a company's financial health.
Working Capital Changes Explained
Changes in working capital accounts (current assets and current liabilities) represent the difference between the opening and closing balances of these accounts during the period. These changes need to be adjusted in the indirect method of calculating operating cash flow because the profit is based on accrual accounting, not cash movements.
- Current Assets: An increase means more funds are tied up (e.g., in inventory or receivables), reducing cash. A decrease means funds are released (e.g., inventory sold, receivables collected), increasing cash.
- Current Liabilities: An increase means the company has received goods/services but hasn't paid cash yet (e.g., increased payables), effectively increasing cash temporarily. A decrease means cash has been used to pay off obligations (e.g., reduced payables), decreasing cash.
By making these adjustments to the net profit, the indirect method converts the accrual-based profit figure into the actual cash generated from the company's day-to-day operations.
Important Questions from Cash Flow Statement
While preparing Cash Flow Statement, purchase of goodwill is treated as:
Identify the correct sequence of the following steps involved in calculating cash flows from operating activities of a company:
(A) Operating profit before working capital changes
(B) Cash generated from operations
(C) Income tax paid
(D) Net cash flow from operating activities
(E) Goodwill amortised
Choose the correct answer from the options given below:
Window dressing is a practice:
Which one of the following are correct in connection with the Common Size Statement?
(A) Expressed as a percentage on revenue from operation
(B) Horizontal analysis
(C) Vertical analysis
(D) Expressed as a percentage on total assets
Choose the correct answer from the options given below:
Arrange the following in proper sequence while preparing Cash Flow Statement:
(A) Net cash flow from operating activities
(B) Cash flow from financing activities
(C) Cash flow from investing activities
(D) Calculate net profit before tax and extraordinary items in working note
Choose the correct answer from the options given below:
