Sources of Cash Flow

Sources of Cash Flow

Cash From Operation

Cash from operations is a major source of cash flow into the business. Only Cash Sales and Cash Receipts from debtors against credit sales are recognized as a source of cash. Similarly Cash Purchases and Cash Payments to suppliers for credit purchases are regarded as the use of cash. In respect of other expenses and incomes also, no consideration is given for outstanding and prepaid expenses and incomes.Cash from operations may be calculated in two ways i.e. Cash Sales Method or Net Profit Method.

i. Cash Sales Method

Under this method, cash from operations is ascertained as under:
Cash from operations = Cash Sales – Cash purchases and Cash Operating
Expenses.
Generally, the income statement shows both cash and non-cash items. In order to ascertain cash sales, cash purchases and cash operating expenses based on income statement, the items of current assets and current liabilities given in the balance sheet should also be taken into account along with items of income and expenditure shown in the income statement. This  method is also known as ‘Income & Expenditure’ method. Let us know how to ascertain cash sales, cash purchases and cash operating expenses and cash from operations under this  method.
Note: Sales made by every firm represent both cash sales and credit sales. On account of credit sales made during the year, the question of collecting debts from debtors arises. As such,  what portion of credit sales which remained uncollected at the end of accounting year is termed as ‘Debtor or Bills Receivable’ and is shown as asset in the Balance Sheet. Hence, the  increase in the amount book-debts or debtors and bills receivable is considered as an increase in credit sales and deducted from total sales and decrease in the amount from debtors and bills receivable is added back. However, the collections made from debtors and cash received against bills receivable would be shown as inflow of cash in the cash flow statement.
Similarly, the purchases made by every firm represents both cash and credit purchases. On account of credit purchases made during the accounting year, the question of payment to creditors arises. As such, that portion of credit purchases which remained unpaid at the end of accounting year is termed as creditors and bills payable shown as liability in the Balance Sheet. Hence, increase in creditors and B/P is considered as increase in credit purchases and deducted from total purchases and decrease in amount of credits and bills payable  is added back. However, payments made to creditors or cash paid against bills payable should be shown as outflow of cash in the cash flow statements.
Important useful points to be noted while calculating cash from operations under the method:
i. Outstanding Expenses: Outstanding Expenses are those expenses which are due to be paid. They are charged, to profit and loss alc but no cash is paid in this respect during the current year. Hence, they are added back while calculating the cash from operations. However, if any expenses of the previous year is given, they may be assumed to have been paid during the y ear and are shown as the outflow of cash in the cash flow statement.
ii. Prepaid Expenses: Are the expenses of the next or subsequent accounting year paid in the current account year or expenses paid in advance. These expenses are not charges to profit and loss a/c. Hence, they are shown as outflow of cash in the cash flow statement. However, if there are prepaid expenses (previous year) given, they are paid in the last or previous  accounting year for the current accounting year, and as such they are added back while ascertaining cash from operation.
iii. Outstanding or Accrued Income: It is an income due to be received, it is credited to profit and loss account but no cash is received. Hence, it is deducted from sources from these operations. However, if there is any outstanding income relating to previous year is given, it may be assumed to have been received during the year and shown as inflow of cash in the cash flow statement.
iv. Pre-received Income: It is the income received in advance. If there is any pre-received income in the current year, it is shown as inflow of cash in cash flow statement. However, if there is any pre-received income (in previous year), it is deducted from sources from operations while ascertaining cash from operations.
Proceeds From Sale of Fixed Assets: Amount received from the sale fixed assets or investments results in the in(low of cash. Hence, it is shown as inflow of cash in cash flow statement. Issue of Shares or Debentures: When the shares or debentures are issued for cash, there is inflow of cash. As such, it is shown as inflow of cash in the cash flow statement.
Raising of Loans: When the money is borrowed from financial institutions in terms loans or cash credits, it amounts to inflow of cash. As such, it is shown as inflow of cash in the cash flow statement.