The direct method of preparing a cash flow statement focuses on the actual cash inflows and outflows related to a company's operating, investing, and financing activities. Here's a step-by-step guide:
Step 1: Identify Cash Inflows and Outflows
- Operating Activities:
- Cash received from customers: Add up all cash collected from sales of goods or services during the period.
- Cash paid to suppliers: Include all cash payments made for inventory, raw materials, and other operating expenses.
- Cash paid to employees: Add up all salaries, wages, and benefits paid to employees.
- Cash paid for other operating expenses: Include all cash payments for rent, utilities, insurance, and other operating costs.
- Investing Activities:
- Cash received from the sale of long-term assets: Include cash received from selling property, plant, equipment, or investments.
- Cash paid for the purchase of long-term assets: Include cash spent on buying new property, plant, equipment, or investments.
- Financing Activities:
- Cash received from issuing debt or equity: Add up all cash received from issuing bonds, notes, or stock.
- Cash paid for debt repayment: Include all cash paid to repay debt obligations.
- Cash paid for dividends: Add up all cash paid to shareholders as dividends.
Step 2: Organize by Activity
- Create a table with three columns:
- Operating Activities
- Investing Activities
- Financing Activities
- List the cash inflows under the appropriate column.
- List the cash outflows (with a negative sign) under the appropriate column.
Step 3: Calculate Net Cash Flow
- Operating Activities: Subtract total cash outflows from total cash inflows to calculate net cash flow from operating activities.
- Investing Activities: Subtract total cash outflows from total cash inflows to calculate net cash flow from investing activities.
- Financing Activities: Subtract total cash outflows from total cash inflows to calculate net cash flow from financing activities.
Step 4: Calculate Total Net Cash Flow
- Add the net cash flows from operating, investing, and financing activities to determine the total net cash flow for the period.
Example:
Let's say a company has the following cash flows for the year:
- Cash received from customers: $500,000
- Cash paid to suppliers: $250,000
- Cash paid to employees: $100,000
- Cash paid for other operating expenses: $50,000
- Cash received from selling equipment: $20,000
- Cash paid for buying new equipment: $40,000
- Cash received from issuing bonds: $100,000
- Cash paid for debt repayment: $30,000
The cash flow statement direct method would look like this:
Activity | Inflows | Outflows | Net Cash Flow |
---|---|---|---|
Operating Activities | |||
Cash received from customers | $500,000 | ||
Cash paid to suppliers | -$250,000 | ||
Cash paid to employees | -$100,000 | ||
Cash paid for other operating expenses | -$50,000 | $100,000 | |
Investing Activities | |||
Cash received from selling equipment | $20,000 | ||
Cash paid for buying new equipment | -$40,000 | -$20,000 | |
Financing Activities | |||
Cash received from issuing bonds | $100,000 | ||
Cash paid for debt repayment | -$30,000 | $70,000 | |
Total Net Cash Flow | $150,000 |
Important Note:
- The direct method provides a more transparent view of actual cash flows compared to the indirect method.
- It is generally preferred by investors and creditors who are looking for detailed information about a company's cash flow.