Home > Cash Flows Statement, Corporate Finance, Financial Accounting, Financial Statement Analysis > Preparation of cash flows statement using Direct Method Example 1

Preparation of cash flows statement using Direct Method Example 1

Cash flows statement prepared using two financial statements, 1st Income Statement and 2nd Balance Sheet.

Before preparing cash flows statement,

a. Analyze Balance Sheet

b. Reordering of Income Statements

Step1:

a. Analyze Balance Sheet:

we will analyze balance sheet each account of current year and previous year. From balance sheet analyzing we extract additional information (AI) for cash flows statement and regroup these additional information in three major categories.

  • Operational Activities
  • Investing Activities
  • Financing Activities

In this tutorial, I will not explain the analyzing of balance sheet, I just provide data in the form of additional information according to above three categories. I will use this categorize additional information for cash flow preparation directly.

Additional Information from balance sheet analyzing:

Additional Information (AI) obtained from analysis of changes in the balance sheet accounts during the current year:-

Cash & Cash equivalents at beginning of the year = Rs.40, 000

At end of the year = Rs.75, 000

Other additional information classified into the three categories i.e. Operating, Investing and Financing Activities, was as follows:-

Additional Information relating to Operating Activities

1. Accounts Receivable increased by Rs.30, 000.

2. Accrued interest i.e. interest receivable decreased by Rs.1, 000 (Dividend revenue recognized on cash basis & interest revenue on accrual basis).

3. Inventory increased by Rs.10, 000 and accounts payable by Rs.15, 000.

4. Short-term prepared expenses increased by Rs.3, 000.

5. Accrued expenses (payable) decreased by Rs.6, 000.

6. Depreciation for the year Rs.40, 000.

7. Interest payable increased by Rs.7, 000.

8. Income tax payable decreased by Rs.2, 000.

Additional Information relating to Investing Activities

1. Marketable Securities (not qualifying as cash equivalent) show debit entries of Rs.65,000 and credit entries of Rs.44,000.

2. Notes Receivable Account shows Rs.17, 000 debit and Rs.12, 000 credits.

3. Purchase of plant assets for Rs.200,000: Cash Rs.160,000 and long-term Note Payable Rs.40,000

4. Sale of plant assets with book value Rs.44,000

Additional Information relating to Financing Activities

1. Borrowed Rs.45, 000 cash by issuing short-term Notes Payable.

2. Repaid Rs.55, 000 on account of principal on Loans & Notes Payable.

3. Issued bonds payable Rs.100, 000 cash.

4. Issued for cash 1000 shares of Rs.10 par value at Rs.50 per share.

5. Cash dividend paid Rs.40,000

Step2:

b. Reordering of Income Statements:

we will reordering the income statement in format of inflows and outflows. Below is the original income statements

 

ALI CORPORATION

INCOME STATEMENT

FOR THE YEAR ENDED JUNE 30, _____

Rs. ____
Net Sales 900000
Cost of Goods Sold 500000
Gross Profit 400000
Operating Expenses
(Includes Depreciation Rs. 40000)
300000
Operating Profit (EBIT) 100000
Other Expenses
Interest 35000
Loss on sale of marketable securities 4000 39000
Profit Before Tax (EBT) 61000
Income Tax Expense 36000
Profit After Tax 25000
Other Income
Dividend Revenue 3000
Interest revenue 6000
Gain on Sale of Plant Assets 31000 40000
Net Income 65000

Reorder the above income statement in the form of inflows and outflows like below,

ALI CORPORATION

INCOME STATEMENT

FOR THE YEAR ENDED JUNE 30, _____

Rs. ____
Inflows
Net Sales 900000
Dividend revenue 3000
Interest Revenue 6000
Gain on Sales of Plant Assets 31000
Total Infows 940000
Outflows
Cost of Good Sold 500000
Operating Expense 

(Includes Depreciation of Rs. 40000)

300000
Interest Expense 35000
Income tax Expense 36000
Loss on Sale of Marketable Securities 4000
Total Outflows 875000
Net Income 65000

Step 3:

Preparation of Cash Flows Statement:

From the above available data in the form of Income Statement and Additional Information (extracted from analyzing of balance sheet). I will prepare cash flows using direct method.

First of all I will classify the account (of income statement and balance sheet) in three main categories i.e. Operating, Investing and Financing Activities. Below is the skeleton of cash flows statement with accounts classification of income statement and balance sheet.

ALI CORPORATION

CASH FLOWS STATEMENTS

FOR THE YEAR ENDED JUNE 30, _____

Cash Inflow from Operating Activities
Cash Inflows from Customers
Cash Inflows from Interest and Dividends
Cash Outflow from Operating Activities
Cash Outflows from Purchases
Cash Outflows from Operating Expenses
Cash Outflows from Other Expenses
Net Cash flow from Operating Activities
Cash Inflow from Investing Activity
Cash Inflow from Assets, Notes Receivable, Marketable Securities
Cash Outflow from Investing Activity
Cash Outflow from Assets, Notes Receivable, Marketable Securities
Net Cash flow Investing Activities
Cash Inflow from Financing Activities
Cash Inflow Bonds, Shares and Dividends
Cash Outflow from Financing Activities
Cash Outflow Bonds, Shares and Dividends
Net Cash Flow From Financing Activities
Net Cash Flow
Cash & its equivalent beginning of the year
Cash & its equivalent end of the year

Step 4:

Cash Inflows from Operating Activities

Customer Description Adjustments
Net Sales INet Sale in PL 900000
Accounts Receivable Increased in BS (AI1) -30000
Actual Cash Received from Customers 870000
Interest and Dividend Description Adjustments
Interest Revenue Interest received in PS 6000
Accrued Interest Interest Receivable decreased in BS (AI2) 1000
Dividend Revenue Dividend Received in PL 3000
Actual Cash Received from Interest and Dividends 10000

Cash Inflows from operating activities = 870000+ 10000 => 880000

Step 5:

Cash Outflows from Operating Activities

Purchases Description Adjustments
Cost of Good Sold Purchases of raw material in PS 500000
Inventory Increase in Inventory in BS (AI2) 10000
Account Payable Increase in Accounts Payable in BS (AI2) -15000
Actual Cash Outflows to Suppliers 495000
Operating Expenses Description Adjustments
Operating Expense Operating Expenses in PS 300000
Prepaid Expenses Short term Prepaid expenses not shown in PS because of accrual, but payment done as BS (AI4) 3000
Accrued Expenses Decreased in BS (AI5) 6000
Depreciation Exp No actual Cash outflow just shown as expense (AI6) -40000
Actual Cash Outflows for Operating Expenses 269000
Other Expenses Description Adjustments
Interest Expenses Interest Paid in PS 35000
Income Tax Expense Income Tax Expense in PS 36000
Interest Payable Interest Payable Increase in BS (AI7) -7000
Income Tax Payable Decrease in BS (AI8) 2000
Actual Cash Outflows for other expenses 66000

Cash Outflow from Operating Activities=495000+269000+66000=>830000

Net Cash Flow from operating activities =Cash Inflow from operating activities – Cash outflow from operating activities

Net Cash Flow from operating activities=880000-830000=>50000

Step 6:

Cash Inflows from Investing Activities:

Investing Accounts Description Adjustments
Marketable Securities Marketable securities sell out in BS (AI1) 44000
Loss on Sale of marketable Securities Expense in PS -4000
Notes Receivable Cash received from notes Receivable in BS (AI2) 12000
Gain on sale of plant assets Gain on sale asset other then book value in PS 31000
Sale of Plant Assets Sale on book value other then gain 44000
Actual Cash Inflows from Investing Accounts 127000

Step 7:

Cash Outflows for Investing Activities:

Investing Accounts Description Adjustments
Marketable Securities Marketable securities Purchases in BS (AI1) 65000
Notes Receivable Cash Paid for notes Receivable in BS (AI2) 17000
Asset Asset Purchases in BS (AI3) 160000
Actual Cash Outflows for Investing Accounts 242000

Net Cash Flows from Investing Activities=Cash Inflows from Investing Accounts-Cash Outflows for Investing Accounts

Net Cash Flows from Investing Activities=127000-242000=>-115000

Step 8:

Cash Inflows from Financing Activities:

Financing Accounts Description Adjustments
Short term notes payable Cash borrowed (AI1) 45000
Bond Issued Cash Borrowed (A3) 100000
Shares 1000 share Rs. 50 per share (AI4) 50000
Actual Cash Inflows for Financing Accounts 195000

Step 9:

Cash Outflows from Financing Activities:

Financing Accounts Description Adjustments
Notes payable Principal paid (AI2) 55000
Dividend Paid Cash Paid (AI5) 40000
Actual Cash Outflows for Financing Accounts 95000

Net Cash flow from Financing Activities=Cash Inflows from Financing Activities-Cash Outflows from Financing Activities

Net Cash flow from Financing Activities=195000-95000=>100000

Step 10:

So far we have calculated the actual cash flows (other then accrual) in operating, investing and financing activities. Now put the calculated values in cash flows statements classification of step 3.

ALI CORPORATION
CASH FLOWS STATEMENTS
FOR THE YEAR ENDED JUNE 30, _____
Cash Inflow from Operating Activities
Cash Inflows from Customers 870000
Cash Inflows from Interest and Dividends 10000 880000
Cash Outflow from Operating Activities
Cash Outflows from Purchases (495000)
Cash Outflows from Operating Expenses (269000)
Cash Outflows from Other Expenses (66000) (830000)
Net Cash flow from Operating Activities 50000
Cash Inflow from Investing Activity
Cash Inflow from Assets, Notes Receivable, Marketable Securities 127000 127000
Cash Outflow from Investing Activity
Cash Outflow from Assets, Notes Receivable, Marketable Securities (242000) (242000)
Net Cash flow Investing Activities (115000)
Cash Inflow from Financing Activities
Cash Inflow Bonds, Shares and Dividends 195000 195000
Cash Outflow from Financing Activities
Cash Outflow Bonds, Shares and Dividends (95000) (95000)
Net Cash Flow From Financing Activities 100000
Net Cash Flow 35000
Cash & its equivalent beginning of the year (40000)
Cash & its equivalent end of the year (75000)

Net Cash flow = 35000

difference between the opening and closing of Cash & its equivalent = 75000-40000 => 35000

  1. coolmanlg
    December 16, 2010 at 8:44 pm

    Thanks for the post. Is it possible to do this with openerp? Can u post a demo please?

    • December 17, 2010 at 5:37 pm

      brother! yes possible, we can develop a new module having name financial statements.and if you asking, is there any module already exist for cash flow statement then my answer is, i am not confirm.
      because i have not seen so far, remember i am not saying no may be any module support this report.so if you got the answer then plz share, else we can work on this direction.

  2. December 3, 2011 at 3:47 pm

    nice. assisted me to understand direct method.

  3. Berhane
    July 2, 2012 at 5:08 pm

    what the difference b/n direct and indirect cash flow

  4. Sunil
    July 27, 2012 at 9:44 am

    nice. assisted me to good

  5. Sunil
    July 27, 2012 at 9:51 am

    can u send me indirect method ?

  6. thabo
    September 7, 2012 at 8:12 am

    i have a problem with balancing the cash flow statement please help

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