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In part 2 we explained the net earnings before tax adjustments using the indirect method . In a CFO statement the final number is the same if we used either methods ( the direct or indirect ) as the difference lies in the way of displaying the statement . In this article we are going to explain practically each term of the CFO statement .
What are the included activities of the CFO statement ?
They are the activities which deal with current assets and liabilities in the financial statement as follows :
Change = last - beginning
Last is the balance of the term at present and beginning is the balance of the term in the last period .
It is known that current assets increase is subtracted in the cash flow statement and the decrease is added . As for liabilities , the increase is added and the decrease is subtracted .
Stock in the cash flow statement
To make a cash flow statement we should have the income statement for the current period and the balance as well as those of the previous period in order to calculate the change in the terms of operating activities or the terms of working capital .
For example the stock change in the years 2017 and 2016
Stock balance in 2017 is one million
Stock balance in 2016 was 750 thousands
Stock change = 1000000-750000= 250000
Thus the stock increased with 250000 meaning that there are purchased goods during the period and there still are goods in the warehouses which are not listed in the income statement . This increase is subtracted in the CFO statement because it is considered a cash outflow . Then the stock change is minus or we deduct 250000 as a cash outflow .
An example of stock decrease
The net stock balance at present is 750 000 thousands .
In the previous period it was one million .
That is there is a decrease of 250000 thousands . This decrease means that part of the sales cost at present is goods bought during the last year , then it is not considered cash outflow . So the decrease is added in the CFO statement as an operating cash inflow .
In other words , if there is an increase in the stock balance this means a cash outflow.
But if there is a decrease then it is a cash inflow .
When we calculate the stock change we ignore the decrease because it is non-cash and in the case of recovery it is the same . That is in the General Ledger we record the actual stock using the warehouse software .
Clients item in the cash flow statement
In the indirect method we figure out the balance change during the two periods ( 2017and 2016)
That's Clients’ gross balance .
2016 it was 10 millions
2017 it was 8 millions
The change = 8 - 10= - 2 millions
This indicates a decrease in the clients’ balance ( - 2 millions ) which is cash inflow that is included in the items of operating activities .
Why is it considered a cash inflow ?
Because the company sales at present added to the sales of the previous period ( clients’ collections ) are 2 millions cash inflow . So the decrease is added in the operating items . To put it another way , the company collected clients’ credits during the last period , its credit balance decreased and it is considered as cash inflow which is included in the operating items and added to the net earnings before tax in the section of operating activities that includes the non-cash revenues and expenses .
Clients’ balance increase
If we want to calculate the change in clients’ balances during 2017 ( 10 millions )and 2016 ( 8 millions ) this increase in their balance ( 2 millions ) is subtracted from the cash flow statement as cash outflow which is deducted from the net earnings before tax .
This shows that there is a part of the sales cycle that is not collected yet at present . The net earnings before tax increased due to the company sales and the increase will be deducted as cash outflow .
In general , clients’ balance increase at present than the previous period is cash outflow and subtracted in the items of operating activities . But the clients’ balance decrease is cash inflow added to the items of operating activities .
Cash inflow added to the items of operating activities
As with stock , we work on the actual clients’ balances recorded in the General Ledger and we ignore the decrease . the other credit balances such as the advance paid expenses like suppliers advance payments , third-party insurance cover guarantee letters, deduction at the source tax and any other credit balances for the company . Meaning the accruals of the company on other parties other than its clients . When we calculate the change in credit balances for example :
Credit balance in 2017 is one million
2016 was 500 thousands
Change = million -500 thousands = 500 thousands
Namely , there is an increase in credit balances during this year of 500 thousands . That is the company paid more money this year compared to the last one which indicates cash outflow with deduction in the CFO statement . Consequently if there is a decrease in the credit balances , it will indicate cash inflow because the company could collect part of its credit in the previous period .
Increase in Current liabilities is added but decrease is subtracted .
Suppliers’ item in the cash flow statement .
Any increase in current suppliers’ balances , compared to the previous balances , shows that the company bought an inventory or purchases that are still unpaid which indicates cash inflow in the items of operating activities .
Why is it considered cash inflow ?
If you bought an forward inventory during the last year and there were sales but you still didn’t pay for the supplier . This is cash inflow , that is :
Suppliers’ balance in 2017 was one million
In 2016 it was 850 thousands
Change = 1 000 000 - 850 000 = 150 000
This means that the increase in unpaid purchases indicates cash inflow in operating activities and vice versa in the case of suppliers’ balances decreasing in the current period ,compared to the present .
So in 2018 suppliers’ balance was 700 thousands
In 2017 it was 900 thousands
Then this is a cash outflow deducted from the CFO statement .
Other credit balances :
They are the company liabilities other than the suppliers such as the clients’ advance payments. They are the amounts collected from clients and company dues as salaries and wages that are unpaid till the balance closure and preparation of financial statements . Also they are company dues for tax authority of all types ( added value , earnings , collections , deductions ) , social insurance , third party insurance and profits distribution creditors .
The increase in the present other credit balances compared to the previous period indicates cash inflow that is added in the CFO statement . If the gross credit balances during 2017 was one million pounds and in 2016 it was 800 thousands . This means cash inflow because the company didn’t pay its liabilities for the last period . On the contrary in the decrease of other credit balances it will be cash outflow and deducted from the CFO statement .
Allocations and operating cash flow
Allocations used are considered cash outflow and are deducted from the cash flow statement ( allocations ) and the accounting treatment for the entry is :
Assume that the company allocated to a litigious dispute 2500000 pounds , the entry is :
2500000 A / litigious dispute expenses
2500000 A / litigious dispute allocations
The expenses are listed in the income statement
2500000 A / profits and losses
2500000 A / litigious dispute expenses
The allocation is a current liability if it is intended to be adjusted over a year .
Using the whole allocation if the dispute is over and 2500000 will be paid ,
There is the creditors’ accruals entry
2500000 A/ litigious dispute allocations
2500000 A / creditors ( the company that won thee case )
On payment
2500000 A / creditors
2500000 A / bank
If the used is just part of the allocation ( 1500000 for example ) and the other part is returned because its purpose is over
1500000 A / litigious dispute allocations
1500000 A / creditors
On payment
1500000 A / creditors
1500000 A /bank
To summarize , used allocations are cash outflow that is deducted from the CFO statement .
Paid income tax is included in the operating activities and is deducted from the CFO statement .Paid income tax is calculated as the following :
Beginning tax balance ( last year ) + present tax ( according to the net profits from the income statement ) - end balance ( present year ) = paid taxes.
In general ,paid profit distributions are financing activities according to the accounting standards . But some people prefer to include profits of shareholders in the financing activities whereas the profits of employees and the board of directors are included in the operating activities . In common profits distribution is included in the financing activities provided that it is listed stably in the same activity for the following periods .
Due to related parties
They are liabilities ( other credit balances ) which involve the accruals for sister companies or affiliated companies .
Due to related parties usually is a current liability meaning that if your due in 2010 was 117297 pounds and in 2011 it became 578699 , that is there is an increase in your due balance which is cash inflow added to the CFO statement
578699 - 117297 = 461402
On the contrary if the due to related parties is increased , then it will be cash outflow .
Of course it is included in the CFO statement .
Due from related parties
It is the opposite of “due to related parties “ . It is the money that sister or affiliating companies owe your company . Assume that in 2010 it was 117297 pounds and in 2011 it reached 578699 pounds , this indicates an increase in due from related parties . This is cash outflow deducted from the CFO statement .
578699 - 117297 = 461402
If there is a decrease in due from related parties , then it is cash outflow and is added to the CFO statement .
These two terms can be other credit or debit balances and they can be separated according to their importance .
Paid financial expenses
Financial expenses are concerned with the interests of bond loans and other interests of bank facilities and loans . Although they are financing activities, especially loans and interests , it is common to include them in the operating activities because they clarify the company operating ability to pay its financing interests and that the operating activity generates large amounts of cash . Of course this is true if there is surplus in operating activities provided stability of listing in either activities .
Important notes in cash flow statements :
Financial interests are listed twice in cash flow . First , in adjustments of net earnings before tax in order to eliminate their effect on the net earnings . Second, in the operating and financing activities and they are deducted from them .
Next part will explain the investing and financing activities using the indirect method .ر
