The following example shows the format and calculation of cash flows from operating activities using direct

method.

Example
Prepare the cash flows from operating activities section of cash flow statement by direct method using the following information:
December 31 Accounts Receivable Prepaid Rent Prepaid Insurance Inventory Accounts Payable Salaries Payable Interest Payable Income Tax Payable 2011 2010

$34,130 $28,410 20,000 6,800 23,030 14,590 8,310 700 2,340 25,000 6,000 15,450 31,300 5,120 360 0

Year Ended December 31 Net Sales Salaries Expense Rent Expense Insurance Expense Interest Expense

2011 64,970 8,610 5,000 3,200 1,650

Solution: Cash Flow from Operating Activities:

Cash Receipts From Customers (1) $59,250

Cash Payments To Suppliers (2) To Employees (3) For Purchase of Prepaid Assets (4) Interest (5) Income Tax (6) Net Cash Flow from Operating Activities 24,290 5,420 7,000 1,310 0 21,230

Working Notes
1) 64,970 + 28,410 - 34,130 2) 23,030 - 15,450 + 31,300 - 14,590 3) 5,120 - 8,310 + 8,610 4) 20,000 + 9,800 + 5,000 + 3,200 - 25,000 - 6,000 5) 360 - 700 + 1,650 6) 0 - 2,340 + 2,340

Additional Information from balance sheet analyzing: Additional Information (AI) obtained from analysis of changes in the balance sheet accounts during the current year:Cash & Cash equivalents at beginning of the year = Rs.40, 000 At end of the year = Rs.75, 000 Other additional information classified into the three categories i.e. Operating, Investing and Financing Activities, was as follows:Additional Information relating to Operating Activities 1. Accounts Receivable increased by Rs.30, 000. 2. Accrued interest i.e. interest receivable decreased by Rs.1, 000 (Dividend revenue recognized on cash basis & interest revenue on accrual basis). 3. Inventory increased by Rs.10, 000 and accounts payable by Rs.15, 000. 4. Short-term prepared expenses increased by Rs.3, 000. 5. Accrued expenses (payable) decreased by Rs.6, 000. 6. Depreciation for the year Rs.40, 000. 7. Interest payable increased by Rs.7, 000. 8. Income tax payable decreased by Rs.2, 000. Additional Information relating to Investing Activities 1. Marketable Securities (not qualifying as cash equivalent) show debit entries of Rs.65,000 and credit entries of Rs.44,000. 2. Notes Receivable Account shows Rs.17, 000 debit and Rs.12, 000 credits. 3. Purchase of plant assets for Rs.200,000: Cash Rs.160,000 and long-term Note Payable Rs.40,000 4. Sale of plant assets with book value Rs.44,000 Additional Information relating to Financing Activities 1. Borrowed Rs.45, 000 cash by issuing short-term Notes Payable. 2. Repaid Rs.55, 000 on account of principal on Loans & Notes Payable. 3. Issued bonds payable Rs.100, 000 cash.

4. Issued for cash 1000 shares of Rs.10 par value at Rs.50 per share. 5. Cash dividend paid Rs.40,000 Step2: b. Reordering of Income Statements: we will reordering the income statement in format of inflows and outflows. Below is the original income statements

ALI CORPORATION INCOME STATEMENT FOR THE YEAR ENDED JUNE 30, _____ Rs. ____ Net Sales Cost of Goods Sold Gross Profit Operating Expenses (Includes Depreciation Rs. 40000) Operating Profit (EBIT) Other Expenses Interest Loss on sale of marketable securities Profit Before Tax (EBT) Income Tax Expense Profit After Tax Other Income Dividend Revenue Interest revenue Gain on Sale of Plant Assets Net Income 3000 6000 31000 40000 65000 35000 4000 39000 61000 36000 25000 900000 500000 400000 300000 100000

Reorder the above income statement in the form of inflows and outflows like below,

ALI CORPORATION

INCOME STATEMENT FOR THE YEAR ENDED JUNE 30, _____ Rs. ____ Inflows Net Sales Dividend revenue Interest Revenue Gain on Sales of Plant Assets Total Infows Outflows Cost of Good Sold Operating Expense (Includes Depreciation of Rs. 40000) Interest Expense Income tax Expense Loss on Sale of Marketable Securities Total Outflows Net Income 500000 300000 900000 3000 6000 31000 940000

35000 36000 4000 875000 65000

Step 3: Preparation of Cash Flows Statement: From the above available data in the form of Income Statement and Additional Information (extracted from analyzing of balance sheet). I will prepare cash flows using direct method. First of all I will classify the account (of income statement and balance sheet) in three main categories i.e. Operating, Investing and Financing Activities. Below is the skeleton of cash flows statement with accounts classification of income statement and balance sheet.

ALI CORPORATION CASH FLOWS STATEMENTS FOR THE YEAR ENDED JUNE 30, _____ Cash Inflow from Operating Activities Cash Inflows from Customers Cash Inflows from Interest and Dividends Cash Outflow from Operating Activities Cash Outflows from Purchases Cash Outflows from Operating Expenses Cash Outflows from Other Expenses Net Cash flow from Operating Activities Cash Inflow from Investing Activity Cash Inflow from Assets, Notes Receivable, Marketable Securities Cash Outflow from Investing Activity Cash Outflow from Assets, Notes Receivable, Marketable Securities Net Cash flow Investing Activities Cash Inflow from Financing Activities Cash Inflow Bonds, Shares and Dividends Cash Outflow from Financing Activities Cash Outflow Bonds, Shares and Dividends Net Cash Flow From Financing Activities Net Cash Flow Cash & its equivalent beginning of the year Cash & its equivalent end of the year (95000) (95000) 100000 35000 (40000) (75000) 195000 195000 (242000) (242000) (115000) 127000 127000 (495000) (269000) (66000) (830000) 50000 870000 10000 880000

Net Cash flow = 35000 difference between the opening and closing of Cash & its equivalent = 75000-40000 => 35000

Cash Inflows from Operating Activities

Customer Net Sales Accounts Receivable

Description INet Sale in PL Increased in BS (AI1)

Adjustments 900000 -30000 870000 Adjustments 6000 1000 3000 10000

Actual Cash Received from Customers Interest and Dividend Interest Revenue Accrued Interest Dividend Revenue Description Interest received in PS Interest Receivable decreased in BS (AI2) Dividend Received in PL

Actual Cash Received from Interest and Dividends

Cash Inflows from operating activities = 870000+ 10000 => 880000 Step 5: Cash Outflows from Operating Activities

Purchases Cost of Good Sold Inventory Account Payable

Description Purchases of raw material in PS Increase in Inventory in BS (AI2) Increase in Accounts Payable in BS (AI2)

Adjustments 500000 10000 -15000 495000

Actual Cash Outflows to Suppliers Operating Expenses Operating Expense Prepaid Expenses Accrued Expenses Depreciation Exp Description Operating Expenses in PS

Adjustments 300000 3000 6000 -40000 269000 Adjustments 35000 36000 -7000 2000 66000

Short term Prepaid expenses not shown in PS because of accrual, but payment done as BS (AI4) Decreased in BS (AI5) No actual Cash outflow just shown as expense (AI6)

Actual Cash Outflows for Operating Expenses Other Expenses Interest Expenses Income Tax Expense Interest Payable Income Tax Payable Description Interest Paid in PS Income Tax Expense in PS Interest Payable Increase in BS (AI7) Decrease in BS (AI8)

Actual Cash Outflows for other expenses

Cash Outflow from Operating Activities=495000+269000+66000=>830000 Net Cash Flow from operating activities =Cash Inflow from operating activities Cash outflow from operating activities Net Cash Flow from operating activities=880000-830000=>50000 Step 6: Cash Inflows from Investing Activities:

Investing Accounts Marketable Securities Loss on Sale of marketable Securities Notes Receivable Gain on sale of plant assets Sale of Plant Assets

Description Marketable securities sell out in BS (AI1) Expense in PS Cash received from notes Receivable in BS (AI2) Gain on sale asset other then book value in PS Sale on book value other then gain

Adjustments 44000 -4000 12000 31000 44000 127000

Actual Cash Inflows from Investing Accounts

Step 7: Cash Outflows for Investing Activities:

Investing Accounts Marketable Securities Notes Receivable Asset

Description Marketable securities Purchases in BS (AI1) Cash Paid for notes Receivable in BS (AI2) Asset Purchases in BS (AI3)

Adjustments 65000 17000 160000 242000

Actual Cash Outflows for Investing Accounts

Net Cash Flows from Investing Activities=Cash Inflows from Investing AccountsCash Outflows for Investing Accounts Net Cash Flows from Investing Activities=127000-242000=>-115000 Step 8: Cash Inflows from Financing Activities:

Financing Accounts Short term notes payable Bond Issued Shares

Description Cash borrowed (AI1) Cash Borrowed (A3) 1000 share Rs. 50 per share (AI4)

Adjustments 45000 100000 50000 195000

Actual Cash Inflows for Financing Accounts

Step 9: Cash Outflows from Financing Activities:

Financing Accounts Notes payable Dividend Paid

Description Principal paid (AI2) Cash Paid (AI5)

Adjustments 55000 40000 95000

Actual Cash Outflows for Financing Accounts

Net Cash flow from Financing Activities=Cash Inflows from Financing ActivitiesCash Outflows from Financing Activities Net Cash flow from Financing Activities=195000-95000=>100000