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  Preparing the Statement of Cash Flows

Introduction to Preparing the Statement of Cash Flows

Deducing net cash flows from operating activities

The first part of the statement of cash flows is the 'cash flows from operating activities'.

There are two issues that can be taken to deriving this figure:

1. The direct method and

2. The indirect method.

The direct method

The direct method includes an analysis of the cash records of the business for the period, selecting all payments and receipts relating to operating activities. These are shortened to provide the total figures for inclusion in the statement of cash flows. Completed on a computer, this is an easy matter, but not several businesses accept the direct method.

The indirect method

The indirect method is the more common method. It depends on the fact that, generally, sales revenue provides rise to cash inflows and expenses provide rise to outflows. The meaning of this is that the figure for profit for the year will be intimately linked to the net cash flows from operating activities. Because businesses have to generate an income statement in any case, information from it can be employed like a starting point to deduce the cash flows from operating activities.

Certainly within a specific accounting period, profit for the year will not generally equal the net cash inflows from operating activities. As described earlier when sales are made on credit, the cash receipt takes place sometime after the sale. The meaning of this is that sales revenue made in the direction of the end of an accounting year will be involved in income statement of that year. Though, most of the cash from those sales will flow into the business, and should be involved in the statement of cash flows, in the subsequent year.

The indirect method of deducing the net cash flow from operating activities is concise in Figure

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Figure: The indirect method of deducing the net cash flows from operating activities

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