The direct method is used in the company to be easily displayed and read by decision makers.
As we clarified the difference between the direct and indirect methods is in the listing of the terms of the cash flow statement from operating activities but the investing and financing activities don’t change .
To prepare a Cash flow statement using the direct method we have to examine each item of the operating activities to see the movement of cash connected to each item either receipts or payments .
Cash flow statement from operating activities
It is called the cash statement so we want to identify if the received amount from clients during the financial period of the statement .
How to calculate the company collections ?
There is no problem in cash sales
The company knows the amount of its cash sales
It is all about credit sales
In the beginning of the financial period you have a credit balance for clients from the previous period and credit sales for the current period and it is probable or even sure to have a collected amount of the debts for the previous and current periods .
The formula of collections from clients =
Current period sales + debit balance in the beginning of the period - debit balance at the end of the period
For example if the year starts with a clients’ debit of one million and the sales during the period are 7millions and the ending debit balance is 4 millions
So the collected amount for the current period =
4 -7+1= 4 millions
Suppliers mean a cash outflow
To figure out the amount paid for suppliers over the year
We check the company purchases, if it is a manufacturing company then the purchases are materials for packing and packaging, spare parts and others . So we deal with suppliers for all kinds of inventory .
How to calculate the cash payment for suppliers
= purchases + suppliers’ balance beginning of the period - suppliers’ balance end of the period
To put it another way, purchases +the money I owe to suppliers at the beginning of the period – the remaining amount for the suppliers at the end of the period .
The idea is that
Assume that You bought an inventory for 5 millions during the period and the company began its financial period with 3 millions debits for suppliers . at the end of the period the debit balance was 4 millions
To calculate the cash payments for supplies you can apply the formula as follows :
5 millions + 3 millions – 4 millions = 4 millions
The main idea is that the company had a debit of 3 millions at the beginning of the period and the purchases were for 5 millions
The ending period remaining is 4 millions
So all debits are 8 millions
And the remaining at the end of the period is 4 millions
Then what was paid is 4 millions ( the difference )
Another point in suppliers’ payments is that you may find it difficult to determine the amount of purchases
Regarding that we follow a periodic or constant inventory and it doesn’t include purchases accounting. Then the best method to calculate the suppliers’ payments is to use a simple formula
The cost of sold goods + end of the period inventory – beginning inventory =purchases during the period
The cost of sold goods ± inventory change – suppliers’ change
Inventory change is end of the period inventory balance – beginning inventory balance
Suppliers’ change is end of period suppliers’ balance – beginning suppliers’ balance
To make it easy to understand
The cost of sold goods is an inventory you had then you sold it and there was a part of it that belonged to the current period and another part belonged to the previous period .Namely you bought part in the current period and another in the previous period.
Also to know how much was paid for the suppliers , you have to identify both the beginning period balance for suppliers and the end of period balance.
Therefore the formula is interconnected.
So to calculate the purchases and inventory of the current period
The cost of sold goods ± inventory change (end of the period inventory balance – beginning inventory balance)
Then we subtract form the result Suppliers’ change (end of period suppliers’ balance – beginning suppliers’ balance )
So the main idea is that I want to identify how much the purchases for the period are and how much I owe the suppliers in the beginning and the end of period balance . In this way , it will be easy to determine the payments for suppliers during the current period .
To give an example : the cost of purchases in 2018 was 5 millions and the beginning inventory balance was 2 millions and the end of the period inventory balance was 2.5 millions while beginning suppliers’ balance was 750 thousands and end of period suppliers’ balance was one million .
Payments for suppliers = the cost of sold goods + inventory change – suppliers’ change
inventory change= 2.5 – 2= .5 millions , ending inventory – beginning inventory = change
Suppliers’ change = 1 - .750 = .250 millions , ending suppliers – beginning suppliers = change
Then we apply the formula: payments for suppliers = the cost of sold goods ± inventory change ± suppliers’ change
So payments for suppliers = 5+ .5 - .250 = 5.250 millions
Other debit balances
They are current assets and sums for the company which are paid for other members in or out the company . These sums will be adjusted such as charges and the covering of guarantee letters or insurances and advances for the employees . Also the prepaid expenses like the renal , to sum up any prepaid payments .
Also like the advanced instalments of suppliers meaning that you paid money for the suppliers but they
Haven’t delivered the goods yet . So in this case the advanced instalments for suppliers are other debit balances and the same for prepaid expenses. The idea is that the other debit balances are any sums for the company that are owned by members other than clients .
Assume that the company started the current financial period with a beginning balance of other debit balances as 600 thousands and at the end of the period it became 600 thousands
This means that there are cash receipts from other debit balances with the amount of 300 thousands namely cash inflow .
It also means that the company was able to collect all the sums it paid in the previous period .
On the contrary if we began the period with a balance of 500 thousands and ended with 650 thousands , it means that there was a cash outflow with the amount of 150 thousands .
In the statement we use the gross number of other debit balances after analyzing each item separately as a reference outside the statement .
To use it later in the financial analysis of cash flow statements .
In addition you can list receipts from debit balances in an item
And the payments of the debit balances in another item so that users can benefit from the financial statements with detailed numbers .
Expenses in the cash flow statement
The company pays for suppliers the value of inventory purchases but there are other expenses . They may be general and administrative, marketing, operating or financing . Of course these are the major expenses accounts and they include each type of expenses types such as salaries .
There are administrative salaries and marketing salaries depending on the place of spending whether it will be the administration or sales centers or factories . Now if you want to know the paid administrative expenses during the period , you may be advised to get it from the trial balance .
Accounting is based on maturity , Meaning that every month we calculate revenues and expenses either collected , paid or not paid . Here we work on the cash flow statement , so I want to determine the general cash expenses = general and administrative expenses + change in prepaid general expenses – change in accrued general expenses
Change = ending balance – beginning balance ( in general )
Why did we add the prepaid expenses?
Because prepayment means that you have already added it the advance in order to connect each month with its paid expenses so you should add it to the general and administrative expenses balance .We simply subtracted accrued expenses because they aren’t paid till then but only connected to the month according to accrual basis .
This is true for marketing and operating expenses as well .
Financing expenses in the cash flow statement
First : both the International and the Egyptian standards didn’t include financing expenses in the operating activity or financing activity but they only state the condition that there must be stability in the place of the item of financing expenses This means that if you used them as operating , so every financial period they would be in listed in the operating .But if you used them as financing , you would list them in the financing . This is because of the comparability basis .
It is common in accounting that they are stated in the operating activity especially if the company works on a high cash flow number , then the financing expenses will be included as operating in order for the company to have a powerful position for the shareholders and banks that it has a high cash flow number from operating activity and can pay the interests for banks easily .
Financing expenses are the interests of loans and facilities and also bonds if existed . In most cases there is no accrual of financing expenses in general .
If you want to calculate the amount of cash paid at any expense
The paid amount +change in prepaid expenses – change in accrued expense
Collected interests and other revenues
Basically the interests of deposits are included in the investing activities . Some of the interests are every 3 months , but from the accounting perspective you record in the book a monthly accrual . This is also true for other revenues .
To illustrate , if you have scrap wastes and sold them , but till the end of financing period you didn’t collect any cash . However it is recorded as a monthly accrued revenue of the period as FROM : A /ACCRUED REVENUE , TO A / WASTES REVENUE
So I want to know the collected interests or other collected revenues in cash .
= interests of deposits and other revenues – change in accrued revenues
In this way I could figure out the amount of cash collected from the interests or other revenues .
The other revenues may be included in the operating activity .
The profits of dividends in the cash flow statement
The idea of financing expenses can also be applied to The paid profits dividends . In other words they can be listed as operating or financing , if I want to know the actual prepaid profits
For example : in the beginning of the year the accrued profits dividends liability was 5 millions and at the end of the year there was 7.5 millions and the net profits during the year was 10 millions . The retained profits balance at the beginning of the period was 20 millions and at the end of the period it became 18 millions . So we want to figure out the payments of profits and dividends .
The answer : initially we have to be aware that the announced profits dividends are different from the paid profits dividends .
That is the company can announce profit dividends of 5 millions , for example , and they are due on the company to the shareholders ( a liability )and the payment decision is another part that is when the company has liquid cash .
In the example : the announced profits dividends is net profits during the period + retained profits balance at the beginning of the period - retained profits balance at the end of the period
Retained profits mean that profits of previous years and the company haven’t distributed them on the shareholders or have used them in another activity , namely that the company has been earning over the period of retaining but it is common that part of the earnings is divided on the shareholders and another part is a spare and a third part is considered retained profits .
In the example a part of retained profits at the end of the period balance is from the beginning balance and the other part is from the profits of the year .
To learn the accrued dividends of the company that it announced as a liability
= beginning period retained profits + the profits of the year – retained profits at the end of the period
= 20 + 18 – 10 = 12 millions
Accrued dividends beginning of the period + announced dividends – accrued dividends at the end of the period
= 7.50 – 12+ 5= 9.5 millions
This means that the company distributed profits of 9.5 millions during the year as cash profits dividends
To use another method , we can put it another way after the company decides to distribute profits on the shareholders which can be after the end of the financial year
The record is as follows FROM A /PROFITS OF THE YEAR
TO A / PROFITS DIVIDENDS
Or FROM A/ RETAINED PROFITS
TO A / PROFITS DIVIDENDS
That is you know the number the company decided to distribute which is 12 millions
The beginning balance was 5 millions
So the gross dividends credit balance is 17 millions.
At the end of the period there are 7.5 millions so the spend is 9.5 millions .
The idea is that we want to know the amount that the company decided to distribute
It is very easy to figure out the paid cash dividends .
Taxes in the income statement
The paid income tax is included in the operating activities and is calculated as follows :
Beginning Accrued tax in the financial position + current tax from the income statement for the current period - ending accrued tax balance in the financial position = the paid tax as tax expenses during the year ( current and deferred ) .
+ accrued income tax at the beginning of the period
+ deferred income tax at the beginning of the period
- accrued income tax at the beginning of the year
= paid cash as an income tax .