Cash Flow Statement: Direct & Indirect Method

Cash Flow Statement is an important Financial Statement that shows inflows and outflows of cash and cash equivalents from its various activities.

Cash Flow Statement indicates the source of cash in a company and the use of cash by the company.

Creating Cash Flow Statements 

• To create Cash Flow Statement of a company, the cash flow from the three activities i.e. Operating, Financing and Investment is required, a combination of cash flows of these activities is the Cash Flow Statement of the company.
• Let us see one by one, how the cash flow of these activities is created.

Cash Flow of Operating Activities

• There are two methods to create the cash flow of Operating Methods viz. Direct Method and the Indirect Method.

Direct Method:

The direct method shows major heads of cash inflows and outflow like cash receipts from the customer, cash payments to suppliers, cash expenses, etc. In this method, companies compute net cash provided by operating activities by adjusting each item in the income statement from an accrual basis to the cash basis as following:

• Cash Receipts from customers = Revenue from operations + Trade receivables in the beginning – Trade receivables in the end
• Cash payments to suppliers = Purchases + Trade Payables in the beginning – Trade Payables in the end.
• Purchases = Cost of Revenue from Operations – Opening Inventory + Closing Inventory.
• Cash expenses = Expenses on accrual basis + Prepaid expenses in the beginning and Outstanding expenses in the end – Prepaid expenses in the end and Outstanding expenses in the beginning.

Example 1: Use the following data of M/S ABC Ltd. to create its cash flow statement

Particulars	Figures for Current Period
i.  Revenue from operations Total Revenue ii. Cost of Raw Materials iii. Insurance Premium Total Expenses Profit Before Tax iv. Income Tax Paid Profit After Tax	500000.00 500000.00 50000.00 37000.00 87000.00 413000.00 13000.00 400000.00

Particulars	Balance at the Beginning of Year	Balance at the End of Year
Trade Receivable Trade Payable Inventory	15000.00 3000.00 20000.00	13000.00 5000.00 24000.00

Solution:

• Cash Receipt from Customer = Revenue from Operations + Trade Receivable at the Beginning – Trade Receivable at the End.

Cash Receipt from Customer = Rs. 502000.00

• Net Purchase = Cost of Revenue – Open Inventory + Close Inventory = Rs. 54000.00

Net Purchase = Rs. 54000.00

• Cash Payment to Supplier = Net Purchase + Trade Payable at the beginning – Trade Payable at End.

Cash Payment to Supplier = Rs. 52000.00 

Cash paid for Insurance = Rs. 37000.00

Creating, Cash Flow of Operating Activities from the data:

Particulars	Amount (Rs.)
Cash Receipt from Customer Cash Payment to Supplier Cash paid for Insurance Premium Cash Generated from Operations Tax Paid Net Cash Inflow from Operations	502000.00 (52000.00) (37000.00) 413000.00 (13000.00) 400000.00

Indirect Method:

• In this method, the process of creating Cash Flow of Operating Activity is just opposite to Direct Method, it starts from the Profit/Loss before tax and follows the following steps:
• Increase in Receivable and Decrease in Payable must be Subtracted and
• Increase in Payables and a Decrease in Receivable must be added.

The following example will clarify the above point
Example 2: Consider the following details of ABC Ltd. and create a cash flow statement using the indirect method:

Particulars	Figures for Current Period
i.                    Revenue from operations Total Revenue ii.                  Cost of Raw Materials iii.                Insurance Premium Total Expenses Profit Before Tax iv.                Income Tax Paid Profit After Tax	500000.00 500000.00 50000.00 37000.00 87000.00 413000.00 13000.00 400000.00

Particulars	Balance at the Beginning of Year	Balance at the End of Year
Trade Receivable Trade Payable Inventory	15000.00 3000.00 20000.00	13000.00 5000.00 24000.00

Solution:

• Profit Before Tax = Rs. 413000.00
• Trade Receivable must be Subtracted = (-2000) = Rs. 2000
• Trade Payable must be Added = Rs. 2000
• Increase in Inventory must be subtracted = (4000) = - Rs. 4000
• Income Tax Paid must be subtracted = (-13000) = - Rs. 13000

Creating, Cash Flow of Operating Activities from the data:

Particulars	Amount (Rs.)
Net Profit before Tax - Trade Receivable - Trade Payable - Increase in Inventory - Income Tax Paid Net Cash Inflow from Operations	413000.00 2000.00 2000.00 (4000.00) (13000.00) 400000.00

We can observe that cash flow statement from both the methods give the same result

Cash Flow of Investing Activities

• Cash Flow of Investment Activities is Very Easy, we just need to calculate the cash flow of individual components and add them. The Example below will clarify.

Example 3: Let us consider the following data from the Balance Sheet of M/S XYZ Ltd and calculate the cash flow of its investments:

Non-Current Assets	2012	2013
Machinery	100000.00	400000.00
Plant and Equipment	50000.00	70000.00
Strategic Investment	50000.00	20000.00

Solution:

• Step 1: The machinery has increased in 2013 as compared to 2012, hence we can say an asset is created by outflow of money. 

Outflow in Machinery = 100000 – 400000 = Rs. (300000)

• Step 2: The Plant and Equipment have increased in 2013 as compared to 2012, hence we can say that asset is created by outflow of money. 

Outflow in Plant and Equipment = 50000 – 70000 = Rs. (20000)

• Step 3: Strategic Investment has decreased in 2013 as compared to 2012, hence we can say that there is an inflow of money by a reduction in the asset.

Inflow in Strategic Investment = 50000 – 20000 = Rs. 30000

Hence, for the year 2013, the cash flow statement of XYZ Ltd. is

Particulars	Amount (Rs.)
Outflow in Machinery	(300000.00)
Outflow in Plant and Equipment	(20000.00)
Inflow in Strategic Investment	30000.00
Net Cash Flow	(290000.00)

Cash Flow of Financing Activities

• The calculation of Cash Flow of Financing Activities is very simple and calculated in a similar manner as cash flow for investing activities is calculated, we shall see the same with an example.

Example 4: Let us consider the following data from the Balance Sheet of M/S XYZ Ltd and calculate the cash flow of its investments:

Non-Current Liabilities	2012	2013
Long term Debt	500000.00	600000.00
Common Stock	100000.00	70000.00
Dividends Paid	100000.00	300000.00

Solution:

• Step 1: Long term Debts have increased in 2013 as compared to 2012, hence we can say that there is a cash inflow.

Inflow of Long-Term Debts = 600000 – 500000 = Rs. 100000 

• Step 2: Common Stock has decreased in 2013 as compared to 2012, hence we can say that there is a cash outflow.

Outflow of Common Stock = 70000- 100000 = Rs (30000) 

• Step 3: Dividend paid in 2013 is more than 2012, hence we can say that there is a cash outflow.

Outflow of Dividend = 100000 – 300000 = Rs (200000)

Non-Current Liabilities	2012
Inflow in Long term Debt	100000.00
Outflow of Common Stock	(30000.00)
Outflow of Dividends Paid	(200000.00)

Cash Flow Statement of a Company

• We have seen the process of creating cash flow of all types of activities involved in an industry, we shall now combine the same and create a combined Cash Flow Statement for the Company. We shall now create the Cash Flow Statement of XYZ Ltd., for which we have calculated individual cash Flows.

Particulars

Amount (Rs.)

Cash Flow from Operating Activities Cash Receipt from Customer Cash Payment to Supplier Cash paid for Insurance Premium Cash Generated from Operations Tax Paid Net Cash Inflow from Operating Activities Cash Flow from Investment Activity Machinery Plant and Equipment Strategic Investment Net Cash Flow from Investment Activities Cash Flow of Financing Activities Long term Debt Common Stock Dividends Paid Net Cash Flow from Financing Activities Net Cash Flow of the Company

502000.00 (52000.00) (37000.00) 413000.00 (13000.00) 400000.00 (300000.00) (20000.00) 30000.00 (290000.00) 100000.00 (30000.00) (200000.00) (220000.00) (110000.00)