Cash flow indirect method - a different approach

Rahul Nandwani (. ) (25 Points)

10 October 2016  
           
1 Indirect Method (Sample Format)        
           
  Net Income Before Tax        
  Add:Depreciation        
  Other Non Cash (Like Forex Fluctuation)        
  Interest Expense (shown under Financing)        
  Loss on Sale of Fixed Assets/Long Term Investment        
           
  Less: Interest/Dividend/Rent Income         
  Profit on sale of Fixed Assets/Long Term Investment        
  Interest Income (incl TDS and shown under Investing)        
  Any Non cash income (Like Forex Fluctuation)        
           
  Funds From Operations        
  Add:(Increase)/Decrease in Current Assets(excl Cash and Cash Equivalents)        
  Add:Increase/(Decrease) in Current Liabilities(excl cash and cash equivalents)      
           
  CFO(before tax)        
  Less:Tax Paid(SA + TDS + Advance for the relevant AY)        
  CFO        
           
  Cash from Investing         
  Sale of Long Term Investment/Fixed Asset        
  (Purchase of Long Term Investment/Fixed Asset)        
  Interest/Dividend/Rent Income (incl TDS)        
  Repayment of Loans/(Loans Given)        
           
  Cash From Financing         
  Sale / (Purchase/Buyback) of Equity/Debt/Pref Shares        
  (Dividend Paid/Interest Expense)        
           
           
2 The question arises why we add Decrease of CA and subtract increase in CA        
  while we add Increase of CL and subtract decrease in CL        
  One justification given by authors is that see if Drs increase by say 500 we did not received 500 over the Gross sales made to drs during the year.
  This logic is valid but fails to justify everything        
  Say TDS or VAT input or Cenvat Credit or Inventories        
  Whether should we add increase or subtract it?        
  One would answer subtract as we do that for other CA         
  But the logic lies in the Fundamental Accounting assumption or equation which is       
  Equity = Assets - Liabilities        
  How is this relevant to cash flow lets see Take this opening Balance sheet  
      Opening B/S  
    Equity   Assets(other than Cash and Cash Equivalents)
           
    Liabilities   Cash and Cash Equivalents
           
           
    Take this closing Balance sheet  
      Closing B/S  
    Equity   Assets(other than Cash and Cash Equivalents)
           
    Liabilities   Cash and Cash Equivalents
           
           
    Subtracting Closing B/S from opening B/S
      Closing - Opening B/S  
    Equity (Clg - Opn) Assets(other than Cash and Cash Equivalents) (Clg - Opn)
           
    Liabilities (Clg - Opn) Cash and Cash Equivalents (Clg - Opn)
           
           
    Taking Assets on the liabilities side since it is taken on the cr side The signs of Clg- Opn would be written as Opn - Clg
      Closing - Opening B/S  
    Equity (Clg - Opn)    
           
    Liabilities (Clg - Opn) Cash and Cash Equivalents (Clg - Opn)
           
    Assets(other than Cash and Cash Equivalents) (Opn  - Clg)    
           
           
    Hence when we take increase of CA we Add decrease and subract increase as equation of opn - clg of CA yield positive when there is decrease and negative when it increases
           
           
           
  So the Above Closing - Opening Is the actual cash flow but that does not help the user  in a  more meaningful way  
           
  Thererfore we show a reco from Net income to Cash flow and show diff activities such as Operating , Investing and Financing
  Take the above sample with comments        
           
  Indirect Method (Sample Format)        
           
  Net Income Before Tax Since we started with NPBT we have to take care and consider Sale/Purchase of Equit Debt Pref and Dividend and Interest paid seperately
  Add:Depreciation Added back therefore we cannot use increase in FA now as Depre effect has been nullified
  Other Non Cash (Like Forex Fluctuation) As it is non cash    
  Interest Expense (shown under Financing) Shown under separate head    
  Loss on Sale of Fixed Assets/Long Term Investment Therefore again we cannot consider opn - clg as we nullified profit/loss to show actual invest in FA/Invt/Loans
           
  Less: Interest/Dividend/Rent Income         
  Profit on sale of Fixed Assets/Long Term Investment Therefore again we cannot consider opn - clg as we nullified profit/loss to show actual invest in FA/Invt/Loans
  Interest Income (incl TDS and shown under Investing) Shown under separate head    
  Any Non cash income (Like Forex Fluctuation) As it is non cash    
           
  Funds From Operations        
  Add:(Increase)/Decrease in Current Assets(excl Cash and Cash Equivalents) Because of working above    
  Add:Increase/(Decrease) in Current Liabilities(excl cash and cash equivalents) Because of working above.Do not consider Tax provision as our base was NPBT
           
  CFO(before tax)        
  Less:Tax Paid(SA + TDS + Advance for the relevant AY) tax paid as we started with NPBT  
  CFO        
           
  Cash from Investing         
  Sale of Long Term Investment/Fixed Asset Actual cash received or paid    
  (Purchase of Long Term Investment/Fixed Asset)        
  Interest/Dividend/Rent Income (incl TDS)        
  Repayment of Loans/(Loans Given)        
           
  Cash From Financing         
  Sale / (Purchase/Buyback) of Equity/Debt/Pref Shares As we started with NPBT    
  (Dividend Paid/Interest Expense) As we started with NPBT    
           
           
  Additional Points        
  Consider Drs. Drs
      Amt Amt  
    Opn   TDS  
    BD recovery   Bad Debts
    Sales   Cash  
           
        Clg  
           
    We conider Opn - Clg    
    Drs
      Amt Amt  
    Opn - Clg   TDS  
        Bad Debts
        Cash  
           
        (BD recovery)
        (Sales)  
           
    i.e All Crs - All Drs(of course excluding balancing figures) would be the general rule for CA
    therefore every debit will have a cr and cr will have a dr
    Consider       
    Sale Dr Debtors Cr P/L
    Here sale is written in negative(As shown above) which will offset cr in PL of Sales
           
    Bad Debts Cr drs Dr P/L
    here cr is in positive which will offset Dr in P/L
           
    TDS Cr Drs Dr TDS Receivable
    Asset - asset effect is offset    
           
    Bd recovery Dr Drs Cr P/l
    here dr is written in negative which will offset the cr in p/l
           
  for Crs        
  It will be All Crs - All Drs         
  and one could analyse the second effects same as drs.        
           
           
           
  For FA/Invst/Loans one could have directly considered increase decrease like drs but it is not that helpful for the users .(dr cr effects would have offset each other)