Note on Cash from Operation under Direct Method

  • Note
  • Things to remember

Determination of Cash from Operating Activities under Direct Method

  1. Cash Sales and Cash Collection from Customers/ Debtors:
    Cash collection from customers includes the cash sales amount and cash received amount from customers or credit sales. The generated cash is determined with the help of changes in the customers’ account which is shown on the assets side of the balance sheet.

  2. Cash Paid to Suppliers for Purchase of Merchandise:
    The purchase of merchandise for the purpose of selling and manufacturing finished goods is the major cash outflow area under operating business. The purchase or cost of goods sold shown in the income statement represents both cash purchase and credit purchase.

  3. Cash Paid to Employees and for Other Expenses:
    Among different types of operating and non-operating expenses, only cash operating expenses are taken into account while determining cash paid to employees and for other expenses. Some of the examples are:

    Operating items

    Non-operating items

    Wages & Rent

    Cost of goods sold

    General office expenses

    Interest expenses

    Tax expenses

    Manufacturing expenses

    Selling & distribution expenses

    Operating expenses (cash only)

    Loss on sale of fixed assets

    Non-operating expenses and losses

    Provision for taxation (if non-current)

    Provision for dividend (if non-current)

    Intangible assets written off

    Fictitious assets written off

    Depreciation

    Premium on redemption of debentures

    Other operating expenses (non-cash)


    Notes:

    • Loss on sale of the plat is a non-operating loss.
    • Depreciation is a non-cash item; hence, it is excluded from operating expenses.
    • Interest expense is to be included in operating section and dividend paid under financing section, if there is no additional information given.

  4. Interest Paid:
    If not given any additional information, interest paid is included under operating section.

  5. Tax Paid:
    Tax paid is considered as the cash outflow from operating revenue. Its amount is determined on the basis of tax expense of the current year and position of outstanding tax.

  6. Interest and Dividend Received:
    Cash flow from Interest and dividend received are disclosed separately. Each is classified in a consistent manner from period to period. They are usually classified as cash inflows because they determine net income or loss.

    On the other hand, they may also be included under investing section as they are treated as the return on investments on shares, debentures, and other assets.

  7. Net cash flow before Extra Ordinary Items (A-B-C-D-E+F):
    While calculating cash flow from operation activities, net cash flow before extraordinary items, is to be found out.

  8. Cash from Extra Ordinary Items:
    Besides ordinary items such as cash sales and cash collection from customers, tax paid, interest and dividend received, etc., there are some other items concerned with the operational cash flow of business such as compensation received from the insurance company, short term borrowing, etc.

    Known as extraordinary items, an increase in their balance is a source of cash inflow and a decrease in their balance indicates cash outflow.

Particulars

Increase

Decrease

Notes payable

Bank overdraft

Compensation receivable from insurance company

Marketable securities (if excluded from cash & equivalent)

Short term investment (if excluded from cash & equivalent)

+

+

+

-

-

-

-

-

+

+

Format for Cash Flow from Operating Activities under Direct Method

Particulars

Rs.

Rs.

Cash flow from operating activities:

a. Cash collection from customers:

Net sales

Decrease in bills receivable

Decrease in accounts receivable

Decrease in sundry debtors

Bad debt recovered

Increase in provision for doubtful debt

Increase in provision of discount on debtors

Discount allowed

Increase in bills receivable

Increase in accounts receivable

Increase in sundry debtors

Decrease in provision for doubtful debt

Decrease in provision of discount on debtors

xxx

xxx

xxx

xxx

xxx

xxx

xxx

(xxx)

(xxx)

(xxx)

(xxx)

(xxx)

(xxx)

xxx

b. Cash paid to suppliers for purchase of merchandise:

Cost of goods sold (op. stock + purchases – cl. stock)

Decrease in bills payable

Decrease in accounts payable

Decrease in sundry creditors

Increase in inventory

Increase in sundry creditors

Decrease in inventory

Increase in accounts payable

Increase in bills payable

Discount received

(xxx)

(xxx)

(xxx)

(xxx)

(xxx)

xxx

xxx

xxx

xxx

xxx

(xxx)

c. Cash paid to employees and for other expenses:

Cash operating expenses including wages (item wise)

Increase in outstanding (o/s) expenses

Decrease in o/s expenses

Decrease in prepaid expenses

Increase in prepaid expenses

(xxx)

xxx

(xxx)

xxx

(xxx)

(xxx)

d. Interest paid:

Interest expense (as per income statement)

Increase in prepaid interest

Decrease in prepaid interest

Decrease in o/s interest

Increase in o/s interest

(xxx)

(xxx)

xxx

(xxx)

xxx

(xxx)

e. Tax paid:

Tax expense (as per income statement)

Increase in prepaid tax

Decrease in prepaid tax

Decrease in o/s tax or provision for taxation

Increase in o/s tax or provision for taxation

(xxx)

(xxx)

xxx

(xxx)

xxx

(xxx)

f. Interest and dividend received:

Interest received (as per income statement)

Dividend received (as per income statement)

Decrease in interest/ dividend receivable

Increase in interest/ dividend receivable

xxx

xxx

xxx

(xxx)

xxx

g. Cash from operation before extra ordinary items (a+b+c+d+e+f)

xxx

h. Cash from extra ordinary items:

Increase in short term borrowings, bank overdraft, etc.

Decrease in short term borrowings, bank overdraft, etc.

xxx

(xxx)

xxx/(xxx)

Net cash flow from operating activities

xxx/(xxx)

Alternatively,

Particulars

Rs.

Rs.

Cash collection from customers:

Net sales

Add:

Sundry debtors of last year

Bills receivable of last year

Accounts receivable of last year

Provision for doubtful debt of current year

Provision for discount on debtors of current year

Bad debt recovered

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

Less:

Sundry debtors of current year

Bills receivable of current year

Accounts receivable of current year

Provision for doubtful debt of last year

Provision for discount on debtors of last year

Discount allowed

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

Cash collection from customers (a)

xxx

Cash paid to suppliers:

Cost of goods sold (opening stock + purchases – closing stock)

Add:

Sundry creditors of last year

Bills payable of last year

Accounts payable of last year

Inventory of current year

xxx

xxx

xxx

xxx

xxx

xxx

Less:

Sundry creditors of current year

Bills payable of current year

Accounts payable of current year

Inventory of last year

Discount received

xxx

xxx

xxx

xxx

xxx

xxx

xxx

Cash paid to suppliers (b)

xxx

Cash paid to employees and for other expenses:

Operating expenses (item wise)

Add:

Prepaid expenses of current year

Outstanding expenses of last year

xxx

xxx

xxx

xxx

Less:

Prepaid expenses of last year

Outstanding expenses of current year

xxx

xxx

xxx

xxx

Cash paid to employees and for other expenses (c)

xxx

Interest paid:

Interest expense (as per income statement)

Add:

Prepaid interest of current year

Outstanding interest of last year

xxx

xxx

xxx

xxx

Less:

Prepaid interest of last year

Outstanding interest of current year

xxx

xxx

xxx

xxx

Interest paid (d)

xxx

Tax paid:

Tax expense (as per income statement)

Add:

Prepaid tax of current year

Outstanding tax or provision for tax of last year

xxx

xxx

xxx

xxx

Less:

Prepaid tax of last year

Outstanding tax or provision for tax of current year

xxx

xxx

xxx

xxx

Tax paid (e)

xxx

Interest and dividend received:

Interest received (as per income statement)

Dividend received (as per income statement)

Add:

Interest/ Dividend receivable of last year

xxx

xxx

xxx

xxx

Less:

Interest/ Dividend receivable of current year

xxx

xxx

xxx

Interest and dividend received (f)

xxx

Cash from operation before extra ordinary items (a-b-c-d-e+f)

xxx

Cash from extra ordinary items:

Add: Increase in bank loan, bank overdraft, etc.

Less: Decrease in bank loan, bank overdraft, etc.

xxx

(xxx)

xxx/(xxx)

Net Cash Flows from Operating Activities

xxx/(xxx)

Illustration:

The income statement of BTS Company for the year is given below:

Particulars

Details Rs.

Amount Rs.

Sales revenue

Less: Merchandise purchased

Salaries & wages

Selling & distribution overhead

Manufacturing overhead

Office & administrative overhead (including depreciation Rs. 50,000)

Net profit

4,00,000

3,00,000

2,00,000

1,00,000

3,00,000

15,00,000

13,00,000

2,00,000

Balance sheets of last and current years:

Particulars

Last year

Current year

Sundry debtors

Sundry creditors

Account receivable

Account payable

Accrued interest

Closing stock

2,00,000

80,000

40,000

70,000

15,000

60,000

3,00,000

1,00,000

35,000

50,000

20,000

80,000

Required: Cash flow from operating activities.

Solution:

Calculation of Cash Flow from Operating Activities

Particulars

Rs.

Rs.

A. Cash collection from customers:

Sales revenue

Decrease in accounts receivable

Increase in sundry debtors

B. Cash paid to suppliers:

Merchandise purchased

Increase in closing stock

Increase in sundry creditors

Decrease in account payable

C. Cash paid to employees and for other expenses:

Salary & wages

Manufacturing overhead

Selling & distribution overhead

Office & administrative overhead (including depreciation Rs. 50,000)

D. Interest paid:

Increase in accrued interest

Cash from operation before extra ordinary items (A+B+C+D)

15,00,000

5,000

(1,00,000)

14,05,000

(4,00,000)

(20,000)

(20,000)

20,000

(4,20,000)

(3,00,000)

(2,00,000)

(50,000)

(3,00,000)

(8,50,000)

5,000

1,40,000

Alternatively,

Calculation of Cash Flows from Operating Activities

Particulars

Rs.

Rs.

Cash collection from customers:

Net sales

Add:

Sundry debtors of last year

Accounts receivable of last year

Less:

Sundry debtors of current year

Accounts receivable of current year

2,00,000

40,000

15,00,000

2,40,000

3,00,000

35,000

17,40,000

3,35,000

Cash collection from customers (A)

14,05,000

Cash paid to suppliers:

Merchandise purchased

Add:

Sundry creditors of last year

Accounts payable of last year

Stock of current year

Less:

Sundry creditors of current year

Accounts payable of current year

Stock of last year

80,000

70,000

80,000

4,00,000

2,30,000

1,00,000

50,000

60,000

6,30,000

2,10,000

Cash paid to suppliers (B)

4,20,000

Cash paid to employees and for other expenses:

Salaries & wages

Manufacturing overhead

Selling & distribution overhead

Office & administrative overhead (including depreciation Rs. 50,000)

3,00,000

2,00,000

3,00,000

50,000

Cash paid to employees and for other expenses (C)

8,50,000

Interest paid:

Accrued interest of last year

Accrued interest of current

15,000

(20,000)

Interest paid (D)

(5,000)

Cash from operation before extra ordinary items (A-B-C-D)

1,40,000

References:

Koirala, Madhav et.al., Principles of Accounting -XII, Buddha Prakashan, Kathmandu

Shrestha, Dasharatha et.al., Accountancy -XII, M.K. Prakashan, Kathmandu

Bajracharya, Puskar, Principle of Accounting-XII, Asia Publication Pvt. Ltd., Kathmandu

 Determination of Cash  Flow from Operating Activities under Direct Method

  1. Cash sales and cash collection from customers
  2. Cash paid to suppliers
  3. Cash paid to employees
  4. Interest paid
  5. Tax paid
  6. Interest and dividend received
  7. Net cash flow before extra ordinary items
  8. Cash from extra ordinary items
.

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