Operating Activities – Direct method
When the direct method of presenting the statement of cash flows is used, the major classes or receipts and payments are listed out, and the final balance of these gives us the net cash flows from operating activities.
The direct method of accounting for cash flows from operating activities starts from scratch and records all cash receipts and payments that are related to operating activities.
By contrast, the indirect method starts with net operating profit and then puts through some adjustments to arrive at the cash flows from operating activities balance.
Keep in mind, both methods will result in the same figure for cash flows from operating activities.
Also, the direct method and indirect method only affect the operating activities category, it doesn’t affect the investing activities or financing activities section of the statement of cash flows.
Cash from sales
Businesses will often sell goods or services on credit.
When we’re preparing the statement of cash flows, only the cash receipts from sales will be included.
To calculate this, take the opening trade receivables, add the sales for the year and deduct the closing trade receivables balance to get the cash received from sales during the year figure.
| € | |
| Opening trade receivables (SOFP) | X |
| Sales (SOCI) | X |
| Deduct: Closing trade receivables (SOFP) | (X) |
| Cash received from sales | X |
Wages and salaries
Companies accrue holiday entitlements and other employee costs, these are recorded in the statement of comprehensive income as they occur.
To calculate the actual cash paid for wages, salaries and other employee entitlements, we:
- take the opening accrued salaries balance from the statement of financial position,
- add the wages expense in the period,
- then deduct the closing balance of accrued salaries.
- This will give us the amount of cash paid for wages and employee entitlements during the period.
| € | |
| Opening accrued wages and employee entitlements (SOFP) | X |
| Wages and salaries expense in period (SOCI) | X |
| Deduct: Closing accrued wages and employee entitlements (SOFP) | (X) |
| Cash paid to employees | X |
Cost of goods sold
Now we’ll take a look at how to calculate how much the company paid to suppliers for its material inputs.
This needs to be worked out as most companies will receive credit terms to pay for their purchases.
To calculate the actual cash paid for purchases of inventory and raw materials, the cost of goods sold, we
- take the cost of goods sold figure from the Statement of Comprehensive Income,
- then add any increase in inventory in the period, or if there’s a decrease in inventory, deduct this.
- Calculate the increase or decrease in inventory by taking the closing balance for inventory and deducting the opening balance.
- Once that’s done, deduct any increase in accounts payable in the period, or add back any decrease in accounts payable.
- Just deduct the closing accounts payable balance from the opening accounts payable balance to work this out.
- This will show us how much cash was paid for inventory and the cost of goods sold during the year.
| € | |
| Cost of goods sold / inventory purchased (SOCI) | X |
| Increase/(decrease) in inventory (SOFP) | X/(X) |
| Decrease/(increase) in accounts payable (SOFP) | X/(X) |
| Cash paid for COGS | X |
Other expenses
There’ll be other categories of expenses noted in the financial statements of the entity.
To calculate the actual cash paid for these other expenses, we
- take the opening balance of these expenses,
- add any expenses incurred during the period, and
- then deduct the closing balance of these expenses.
Make sure you don’t include any depreciation, amortisation or other non cash expenses in this calculation.
| € | |
| Opening balance of other expenses (SOFP) | X |
| Other expenses incurred during period (SOCI) | X |
| Deduct: Closing balance of other expenses (SOFP) | (X) |
| Cash paid for other expenses | X |