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A thread on Cash flows from operations:
Cash flow from operations is one of the most important metrics to analyse business core profitability
Today I try to explain it in a simple way. Grab a pack of Dark fantasy biscuits & Let's get started
Cash flow from operations is one of the most important metrics to analyse business core profitability
Today I try to explain it in a simple way. Grab a pack of Dark fantasy biscuits & Let's get started
The motive of every business out there is to make profits. Accountants calculate profits by deducting income from expenses. However, It is an accounting profit and you need to make adjustments to arrive at cash flows
First, it includes non-operating items like interest, dividend, etc., The company you invested, can sell some assets for profits, or invest a lump sum in Bank deposit to earn interest & show these as incomes
Second, it includes non-cash items like depreciation, provisions which don't impact cash flows in reality.
Lastly, accounting profits dont get adjusted for working capital changes
The op cash flow solves all these concerns. Let's look at the calculation process
Lastly, accounting profits dont get adjusted for working capital changes
The op cash flow solves all these concerns. Let's look at the calculation process
The calculation:
First, you start with profits before taxes. Next, you adjust for non-operating & non-cash items. And then you account for the working capital changes. Lastly, you deduct taxes paid to arrive at cash flow from operations.
First, you start with profits before taxes. Next, you adjust for non-operating & non-cash items. And then you account for the working capital changes. Lastly, you deduct taxes paid to arrive at cash flow from operations.
Case study:
Before reading further, remember these
•Non-cash/non-operating exp will be added
•Non-cash/non-operating incomes will be deducted
Before reading further, remember these
•Non-cash/non-operating exp will be added
•Non-cash/non-operating incomes will be deducted
Observations from the above cash flow statement:
•It started with Profits before taxes
•Non-cash expenses like Depreciation, allowance for receivables, provisions have been added
•Non-operating incomes like Interest & dividend income have been deducted
•It started with Profits before taxes
•Non-cash expenses like Depreciation, allowance for receivables, provisions have been added
•Non-operating incomes like Interest & dividend income have been deducted
•Non-operating expenses like Finance cost & loss on the sale of assets have been added
•Non-cash income like Liability written off back has been deducted
•Stripping activity adjustment is a specific item applicable only for this business.
•Non-cash income like Liability written off back has been deducted
•Stripping activity adjustment is a specific item applicable only for this business.
We are halfway through, let's adjust for Working capital changes. The approach to use here is
•Increase in CA
Deduct
•Decrease in CA Add
•Increase in CL Add
•Decrease in CL Deduct
•CA - Current assets, CL - Current liabilities
•Increase in CA
Deduct•Decrease in CA
Add•Increase in CL
Add•Decrease in CL
Deduct•CA - Current assets, CL - Current liabilities
I will try to explain why you need to do adjust for Working capital changes to arrive at cash flows with some examples
Example 1:
Say, a co made sales of Rs 100 out of which Rs 50 were cash sales & Rs 50 were credit sales. Sales will be recorded as Rs 100 in the profit and loss statement & receivables increase by Rs 50 in the balance sheet
Say, a co made sales of Rs 100 out of which Rs 50 were cash sales & Rs 50 were credit sales. Sales will be recorded as Rs 100 in the profit and loss statement & receivables increase by Rs 50 in the balance sheet
Here is the important part. Do think about what exactly happened here. The Rs 50 has been recorded as income despite no cash receipt. Hence you deduct the increase in trade receivables (CA) of Rs 50 to arrive at cash flows.
Example 2:
•Say, the co has sold some short term investments to receive cash. So the Decrease in current assets will be added to arrive at cash flows
•Say, the co has sold some short term investments to receive cash. So the Decrease in current assets will be added to arrive at cash flows
Example 3:
•Say the co has taken a bank overdraft of Rs 100. It appears on the liability side of the balance sheet but finds no place in the profit & loss statement. Hence Increase in current liabilities will be added to arrive at cash flows
•Say the co has taken a bank overdraft of Rs 100. It appears on the liability side of the balance sheet but finds no place in the profit & loss statement. Hence Increase in current liabilities will be added to arrive at cash flows
Example 4:
•Say the co now repaid short term loan using cash. Similar to example 3, it won't appear in the profit & loss statement. So the decrease in current liabilities will be deducted to arrive at cash flows
•Say the co now repaid short term loan using cash. Similar to example 3, it won't appear in the profit & loss statement. So the decrease in current liabilities will be deducted to arrive at cash flows
Having said all that, going back to the sample cash flow statement
•Increase in trade receivables deducted
•Increase in inventories deducted
•Increase in financial assets deducted
•Decrease in financial liabilities deducted
•Increase in trade payables added
•Increase in trade receivables deducted
•Increase in inventories deducted
•Increase in financial assets deducted
•Decrease in financial liabilities deducted
•Increase in trade payables added
Finally, the taxes paid have been deducted to arrive at net cash flow from operating activities.
To conclude, let's quote the famous phrase 'Cash is the king'. That's it, folks. Like & retweet, if u find the thread value-added. Have a great day.
To conclude, let's quote the famous phrase 'Cash is the king'. That's it, folks. Like & retweet, if u find the thread value-added. Have a great day.
