1. Operating Cash Flow
The entity’s primary revenue-generating operations are its operating activities. The cash flows connected with sales, purchases, and other costs are generally included in cash flow from operations. The company’s chief financial officer (CFO) decides whether to show operational cash flow in a direct or indirect manner.
Presenting Directly: Cash in from sales, cash out for capital expenditures, and so on are shown as a list of cash flows in operating cash flows. Because indirect presentation is more prevalent, this is a straightforward but rarely utilized approach. Operating cash flows are reported in an indirect manner as a reconciliation from profit to cash flow. The cash flow statement does not include all real cash flows, but rather “reasons why cash flow differs from profit.”
Depreciation decreases earnings but has no effect on cash flow (it is a non-cash expense). As a result, it has been reinstated. Similarly, if the beginning point profit in the income statement is greater than interest and tax, interest and tax cash flows must be subtracted before being considered as operational cash flows.
There is no precise recommendation on the profit amount to utilize in the reconciliation. Operating profit, profit before tax, profit after tax, and net income are all terms used by different firms. Clearly, the specific beginning point for the reconciliation will define the exact modifications that must be made to arrive at an operational cash flow figure.
2. Investing Cash Flow
The acquisition and disposal of non-current assets and other investments not included in cash equivalents are included in cash flow from investing operations. The cash flows connected with buying or selling property, plant, and equipment (PP&E), other non-current assets, and other financial assets are generally referred to as investing cash flows.Capital expenditures are funds spent on acquiring PP&E. (CapEx).
3. Financing Cash Flow
Financing operations generate cash flow by causing changes in the amount and composition of the entity’s equity capital or borrowings. Borrowing and repaying bank loans, as well as issuing and buying back shares, are all examples of financing cash flows. A dividend payment is also considered a financing cash flow.
Free Cash Flow
Different cash flow metrics are used by investment bankers and finance professionals for different objectives. A popular metric used for DCF valuation is free cash flow. Free cash flow, on the other hand, has no clear definition and can be computed and used in a variety of ways.
Interest and Cash Flow
There are two methods to display interest expenditure in the cash flow statement under IFRS. Many firms report operating cash flows that include both interest collected and interest paid. Others consider interest earned as an investment and interest paid as a financing cash flow. The approach is determined by the finance director’s preference.
Interest paid and received are always regarded as operational cash flows under US GAAP.
How to Prepare a Statement of Cash Flows
The direct method or the indirect technique can be used to display the operational part of the statement of cash flows. The investment and financing portions are the same in both methods; the only variation is in the operational section. The direct method displays the most common types of gross cash collections and payments. The indirect approach, on the other hand, starts with net income and adjusts profit/loss for transaction impacts. In the end, whether using the direct or indirect technique, cash flows from the operational sector will provide the same outcome; however, the presentation will change.