How to Prepare a Direct Cash Flow Statement
Preparing a direct cash flow statement is an essential part of financial analysis for businesses. It provides a clear picture of the cash inflows and outflows from a company’s operating activities, helping stakeholders understand the cash-generating ability of the business. In this article, we will discuss the steps to prepare a direct cash flow statement, ensuring that you have a comprehensive understanding of the process.
Step 1: Gather the necessary financial information
To begin preparing a direct cash flow statement, you will need the following financial information:
1. Income statement: This will provide you with the net income of the company for the period under consideration.
2. Balance sheet: The balance sheet will help you identify the changes in current assets and liabilities, which are crucial for calculating cash flows from operating activities.
3. Cash flow statement (if available): If the company has already prepared a cash flow statement, you can use it as a reference to identify any discrepancies or errors.
Step 2: Calculate cash flows from operating activities
The direct method of preparing a cash flow statement focuses on the cash inflows and outflows directly related to the company’s operating activities. Here’s how to calculate it:
1. Start with net income: Begin by taking the net income from the income statement.
2. Adjust for non-cash expenses: Add back any non-cash expenses, such as depreciation and amortization, as they do not involve actual cash outflows.
3. Adjust for changes in working capital: This involves analyzing the changes in current assets and liabilities. For example, an increase in accounts receivable or inventory would reduce cash flow, while a decrease would increase cash flow. Similarly, an increase in accounts payable or accrued expenses would increase cash flow, while a decrease would reduce it.
4. Sum up the adjustments: Add the adjustments to the net income to arrive at the cash flow from operating activities.
Step 3: Calculate cash flows from investing and financing activities
After calculating the cash flow from operating activities, you need to determine the cash flows from investing and financing activities:
1. Cash flows from investing activities: This includes cash inflows and outflows related to the purchase and sale of long-term assets, such as property, plant, and equipment, as well as investments in other companies. For example, if the company sold an asset, it would be a cash inflow; if it purchased an asset, it would be a cash outflow.
2. Cash flows from financing activities: This includes cash inflows and outflows related to the company’s capital structure, such as issuing or repurchasing shares, taking on or repaying debt, and paying dividends. For instance, if the company issued new shares, it would be a cash inflow; if it repurchased shares, it would be a cash outflow.
Step 4: Sum up the cash flows
Finally, sum up the cash flows from operating, investing, and financing activities to arrive at the net increase or decrease in cash for the period. This figure represents the total cash generated or used by the company during the period.
In conclusion, preparing a direct cash flow statement is a straightforward process that involves gathering financial information, calculating cash flows from operating activities, and determining cash flows from investing and financing activities. By following these steps, you can gain valuable insights into a company’s cash-generating ability and financial health.
