Statement of Cash Flows Template includes a section called \u201cCash flows from operating activities\u201d or as we have called it in our previous posts, \u201cOperational cash flows\u201d. Either way you call it, is fine. But what is this \u201cOperational cash flow\u201d, what\u2019s included and how are they measured?<\/p>\n
The IFRS under which also our Statement of Cash Flows Template is prepared defines operating cash flow as cash generated from operations less taxation and interest paid, investment income received and less dividends paid. Note that interest paid and interest and dividends received are usually shown under operational cash flows, though they may also be disclosed under financing activities. In addition, dividends paid may also be shown under both operational and financing activities. For an example by showing them under operating activities it represents the ability to pay dividends to owners from cash generated through \u201dbusiness as usual\u201d activities.
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\nThe operational cash flow can be measured by using two different types of methods. They are called \u201cdirect\u201d and \u201cindirect\u201d.<\/p>\n
While the direct method discloses major classes of gross cash receipts and payments, the indirect method requires adjustments to net income. In more detail, the indirect method uses net income as a starting point and by making adjustments for all transactions for non-cash items, adjusting from all cash-based transactions reaches to the end result of \u201cCash generated from operations\u201d. Basically an increase in an asset account is subtracted from net income and an increase in a liability account is added back to net income. Why is that? Think about it. When your assets increase (say accounts receivable for an example), you have some cash hold up somewhere meaning that you have less resources to use regardless of the fact that you have earned profit from the sale of goods or services which resulted in increase of the receivable balance. It works the same way for liabilities; if they decrease it means that you have paid up something so the cash has flown out of the company. So in a nutshell the accrual basis accounting and net income is converted into real cash flow.<\/p>\n
The Statement of Cash Flows Template includes in the section \u201cCash flows from operating activities\u201d a line called \u201cCash generated from operations\u201d, which essentially is calculated using the above mentioned principle. The other lines disclosed in our Statement of Cash Flows Template under the same section are for cash outflows from interest and dividends paid. We will discuss them in our future posts.<\/p>\n