Home » Accounting Explanation » Cash flow statement


Procedure of Preparing Cash Flow

Step No.1
We begin preparing cash preparing cash flow statement from the figure of net profit or loss (taken from income statement)

Step No.2
Then, we made Adjustments for non cash items which are included in the net profit or loss such as Depreciation, Provisions, and Gains/losses on the sales of fixed assets etc. and it will give us the figure of “Operating cash flows before movements in working capital”

Step No.3
Then, we work for the working capital movements i.e. increase or decrease in items of current assets and liabilities, we will add and deducts these item (But cash will not be include in it) and will get the figure of “Cash from operating activities” after that

Step No.4
Now we have to add or subtract the investing and financing activities in “Cash from operating activities” to come across the figure of “net increase or decrease in cash and cash equivalent during the year or period”

Step No.5
Then we will, finally, add opening balance of cash and cash equivalents to “net increase or decrease in cash and cash equivalent during the year or period”

Step No.6
And that’s it. We got the figure of closing balance of cash and cash equivalent


Remember that while preparing cash flow statement:

  • Always add an inflow of cash and cash equivalents
  • Always subtract an outflow of cash and cash equivalents


EXAMPLE

Following are the balance sheets of X.Y.Z Enterprise at the date of December 31, 2010 and December 31, 2011.


Description
31-12-2010
31-12-2011
Assets
Current assets
Cash (overdraft)
Debtor
Prepaid insurance expenses
Stock
Non current assets
Machinery
Land
Other fixed assets
Accumulated depreciation expense

Capital and liabilities
Capital (opening)
Net Profit
Drawings
Capital (closing)

Current or short term liabilities
Accrued rent expense
Creditors




(100,000)
450,000
100,000
400,000

100,000
0
1050,000
(75,000)
1,925,000


1,250,000
200,000
(50,000)
1,400,000


125,000
400,000
1,925,000


(485,000)
500,000
50,000
650,000

250,000
350,000
1050,000
(175,000)
2,190,000


1,400,000
275,000
(100,000)
1,575,000


100,000
515,000
2190,000

Other information:

1) The business purchased land at the cost of $350,000
2) Machinery purchased during year costing 250,000
3) Machinery disposed or sold for 60,000. It had cost $100,000 and book value $40,000
4) Depreciation expenses on all fixed assets (including machinery) for the year 2011 was 160,000

Requirement: You are required to prepare a Cash flow statement for the year ended on 31 December 2011



SOLUTION:



X.Y.Z Enterprise
Cash flow statement
For the year ended on 31 Dec, 2011

Operating activities
Net profit of the year
Adjustment for non-cash items
Depreciation expenses
Gain on the sale of machinery
Operating cash flow before movement in working capital
Increase in debtors
Increase in stock or inventory
Decrease in prepaid insurance expense
Increase in creditors or accounts payable
Decrease in accrued rent expenses

Net cash from operation activities

Investing activities
Purchase of machinery
Sale or disposal of machinery
Land brought
Net cash flow from investing activities

Financing activities
Drawings or withdrawals by the owner
Net cash from financing activities
Net increase in cash and cash equivalent
Cash and cash equivalent at the beginning of year

Cash and cash equivalent at the end of year

275,000

160,000
(20,000)
415,000
(50,000)
(250,000)
50,000
115,000
(25,000)

                 1,290,000


(250,000)
60,000
(350,000)
                 285,000


(100,000)
                 (100,000)     
                 (385,000)
                 (100,000)     

                 (485,000)




Explanation:


Net profit for the year

Net profit for the year=275,000

The amount of profit made during the year. This figure is taken from 31 December 2011 Balance sheet

Depreciation expenses

Total depreciation expenses for year=$160,000

The total amount of depreciation expenses on all fixed assets. Since the depreciation expenses is a non-cash item, we have added them back to net profit figure

Gain on sale or disposal of machinery

The business disposed or sold machinery for $60,000 which had book value =40,000. Therefore, the gain on sale of machinery must be $20,000 (100,000-40,000=60,000).

Gain or loss on disposal of fixed asset = Market value of a fixed asset – Book value of a fixed asset

In this case

Gain on disposal of fixed asset = 60,000 – 40,000

Gain on disposal of fixed asset = 20,000

Gain on disposal of fixed assets is a non-cash item which is why we subtract the figure of gain from net profit in cash flow statement

Increase in debtors

Stock on 31 December, 2010 = 450,000
Stock on31 December, 2011 = 500,000


Debtors on 31 December, 2010 were 450,000 and on 31 December, 2011 they are at 500,000. Therefore, debtors have increased by 50,000 (450,000-500,000=50,000) which is an outflow of cash

Increase in stock or inventory

Stock on 31 December, 2010 = 400,000
Stock on31 December, 2011 = 650,000

Therefore, Increase in stock: 400,000-650,000 = 250,000 which indicates that business has brought goods and it is an outflow of cash


Decrease in prepaid insurance expense

Prepaid expenses on 31 December, 2010 = 100,000
Prepaid expenses on 31 December, 2011 = 50,000

Hence, decrease in prepaid expenses: 100,000-50,000 = 50,000 which signifies that the business has decreased its prepaid expenses which reduce the outflow of business cash

Increase in creditors or accounts payable

Creditors on 31 December, 2010 = 400,000
Creditor’s on31 December, 2011 = 515,000

Consequently increase in creditors: 400,000-650,000= 115,000 which indicates that business is getting cash from creditors and therefore, this figure is added in the cash flow statement

Decrease in accrued rent expenses

Accrued expenses on 31 December, 2010 = 125,000
Accrued expenses on31 December, 2011 = 100,000

As a result, Increase in creditors: 125,000-100,000= 25,000 which points out that business is paying cash and therefore, this figure is subtracted in the cash flow statement

Purchase of machinery

Cash payment for the purchase of machinery =250,000

Purchase of fixed asset will definitely decrease the business cash. Thus, an outflow of cash

Sale or disposal of machinery

Cash receipt for selling machinery= 60,000

Sale of bring cash into business that’s why it is an inflow of cash

Land brought

Purchase of land =350,000

Treatment of land is same as machinery because both are fixed assets

Drawings

Drawings = 100,000

Since the owner is withdrawing some cash out of business, it is an outflow of cash and outflow of cash is always considered as a subtraction in cash flow statement