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)
Join 40,000+ readers and get free notes in your email