We will continue working through the preparation of a cash flow statement using the direct method
These are the line items that you will need to fill in to complete a cash flow statement.Cash Flow from Operating Activities:
As you can see, any use of cash (such as payments to suppliers or employees) is subtracted and any source of cash (such as cash sales) is added to compute total net cash from operating activities. Here is an example of how a small business’ cash flow from operating activities using the direct method might look:
Sources of cash (additions): Cash received from customers$ 10,000 Dividends received$ 700 Cash provided by operating activities$ 10,700Uses of cash (subtractions): Cash paid for inventory$ 3,000 Cash paid for insurance$ 1,500 Cash https://paydayloanstennessee.com/cities/memphis/ paid for selling expenses$ 1,500 Interest paid$ 300 Taxes paid$ 1,450Net Cash from Operating Activities$ 2,950
While it seems simple enough, there are various reasons that many companies do not opt for this format. While computerized accounting systems could make this relatively easy, a small business with many small cash sales and a manual accounting system might find it harder to determine total cash received.
To compile a statement of cash flows from operations using the direct method, an in-depth knowledge of the business and its accounting methods is required. That is, the preparer needs to be thoroughly familiar with the manner in which sales are recorded and expenses are incurred and paid. As a small business owner, this might be information that you are very comfortable assembling. If this is the case, then prepare the statement of cash flows for your business by using the direct method.
Tip… One option that might make the calculation of cash received from customers easier is to estimate it based on changes in some balance sheet accounts: Take accounts receivable at the beginning of the year, add to it sales for the period, and then subtract accounts receivable at the end of the year to compute how much in cash was collected.
As noted earlier, even if the direct method is used, net income is such an important accounting concept that an additional statement reconciling the net income shown on the profit and loss statement with cash flow from operating activities must be prepared. What this means is that according to generally accepted accounting principles, if you prepare cash flow from operating activities using the direct method, you must also prepare it by the indirect method on a supplemental statement. (While it may strike you as twice as much work, information on the direct method is presented in this Business Builder because it is the method preferred by bankers and accountants.)
Then an explanation of the indirect method will be given. This Business Builder assumes that you will be working through both methods in order to choose which method will work b est for you. Information on financing and investing activities included in the description of the direct method is important for both types of cash flow statements.
One reason may be the number of calculations necessary to compute some of the categories, such as cash received from customers
Cash flow from investing activities is the second part of both types of cash flow statements. Investing activities are the changes to your cash position owing to the buying or selling of noncurrent assets. This includes selling and replacing equipment that wears out or acquiring a new building or land so that your company can grow.
Investing activities can also include the purchase or sale of stock, bonds, and securities. Lending money and receiving loan payments are also considered investing activities. For a small business, the investing activities section of a cash flow statement usually reports the following information: