Ascertaining Cash Flow from Operating Activities

Meaning of Operating Activities:

Operating activities are the operations of a company directly associated with furnishing its commodities and/or services to the marketplace. These are the enterprise’s focus trading pursuits, such as producing, allocating, retailing and marketing a good or service.

Operating activities are the principal source of revenue and expenditure in a firm. Hence, the determination of cash flows from operating activities demands special consideration.

As per Accounting Standard -3, a firm should record cash flows from performing pursuits either by utilising:

  • A direct method of how important sections of gross cash payments and gross cash receipts are revealed

OR

  • An indirect method whereby net profit or loss is duly adjusted for the effects of :
  • Proceedings of a non-cash kind
  • Any accruals or deferrals of past/future working cash receipts
  • Items of income or expenses associated with investing or financing cash flows. It is necessary to specify here that below the indirect method, the outset point is net P/L before taxation and extra ordinary things as per Statement of Profit and Loss of the company. Then this amount is for non-cash items, etc., adjusted for determining cash flows from functioning pursuits.

Additional Reading: Cash Flow Statement Preparation

Consequently, cash flow from operating activities can be ascertained using either the Indirect method or the Direct method. These processes are explained in detail as follows :

  • Direct Methods: As the name implies, under direct method, significant titles of cash outflows and inflows (namely employee benefits expenses paid, cash received from trade receivables, etc.,) are contemplated.

It is significant to perceive here that items are reported on accrual data in the statement of P&L. Therefore, some changes are made to transform them into a cash basis :

Ascertaining Cash Flow from Operating Activities 1
Ascertaining Cash Flow from Operating Activities 2
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  • Indirect Method: Indirect method of determining cash flow from operating pursuits starts with the amount of net P/L. This due to the statement of P&L includes the results of all operating activities of a firm. However, Statement of P&L is outlined on an accrual base and not on a cash basis. It also involves some non-operating items, namely, P/L on sale of fixed assets, interest paid, etc., and non-cash items such as goodwill to be written-off, depreciation, etc., Hence, it becomes important to regulate the amount of net P/L as depicted by Statement of P&L for landing at cash flows from operating activities.

The above mentioned is the concept, that is elucidated in detail about the Ascertaining Cash Flow from Operating Activities for the class 12 Commerce students. To know more, stay tuned to BYJU’S.