Cash Flow Statement
Operating cash flow: the indirect method
Adjust net profit before tax for non-cash items, non-operating items and working capital changes.
Most companies find their operating cash flow by the indirect method: start with profit, and adjust it until it shows cash.
Step 1: net profit before tax and extraordinary items. If it is not given, rebuild it: the change in the surplus (profit and loss balance) + tax provided + dividends + transfers to reserves during the year.
Step 2: adjust for items that are not operating cash.
- Add non-cash charges: depreciation, goodwill or other intangibles written off, provisions.
- Add non-operating expenses: interest paid (it is financing), loss on sale of assets.
- Deduct non-operating incomes: interest and dividends received, profit on sale of assets (they are investing).
Step 3: adjust for changes in working capital.
| Change | Effect on cash |
|---|---|
| Current asset goes up | deduct |
| Current asset goes down | add |
| Current liability goes up | add |
| Current liability goes down | deduct |
Step 4: deduct income tax paid. Find it from the provision for tax: tax paid = opening provision + tax charged this year − closing provision.
Example: profit before tax 3,00,000; depreciation 40,000; profit on sale of land 20,000; inventory up 30,000; trade payables up 10,000. 3,00,000 + 40,000 − 20,000 − 30,000 + 10,000 = 3,00,000.
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