Question

Riyadh Star, Balance Sheet Statement December 31, 2018 & December 31, 2019
	2018		2019
Cash	$         104,000		$       123,250
Accounts Receivable	183,350		100,000
Inventory	250,000		210,000
Prepaid Expenses	80,000		120,000
Equipment (Net)	584,650		800,000
Total Assets	$      1,202,000		$    1,353,250
Accounts Payable	$         220,000		$       180,000
Salary Payable	94,000		56,250
Interest Payable	20,000		37,000
Bonds Payable	320,000		300,000
Common Shares	370,000		580,000
Retained Earnings	178,000		200,000
Total Equity and Liabilities	$      1,202,000		$    1,353,250

Riyadh Star, Income Statement for the Year Ended Dec 31, 2019
Sales	$      1,255,250
Cost of Goods Sold	822,000
Gross Profit			433,250
Salaries Expenses	203,945
Interest Expenses	75,000
Depreciation Expenses	60,000
Tax Expenses	42,305
Total Expenses			381,250
Net Income			$        52,000

In addition:

(1) Equipment costing $215,350 was purchased and the company paid for it by issuing 10,735 shares at $10 each, and the remainder was paid in cash.

(2) The Star declared and paid cash dividends at the end of 2019.

Requirements:

(1) Prepare cash flow statement for the period ended on Dec 31, 2019 using direct method

(2) Prepare cash flow statement for the period ended on Dec 31, 2019 using indirect method

(3) Determine the balance of free cash flows on Dec 31, 2019 under both methods and comment on it.

Answer 1

		ANSWER
	CASHFLOW STATEMENT OF RIYADH STAR FOR THE YEAR ENDED 31ST DECEMBER 2019
	DIRECT METHOD
	CASH FLOW FROM OPERATING ACTIVITIES				$
	Cash received from customers				13,38,600
	Cash paid to suppliers & other expenses				(8,22,000)
	Tax paid				(42,305)
	Prepaid expense				(40,000 )
	Salary paid				(2,41,695 )
	NET CASH PROVIDED BY OPERATING ACTIVITIES   (A)				1,92,600
	CASH FLOW FROM INVESTING ACTIVITIES
	EQUIPMENT PURCHASED				(1,68,000)
	NET CASH USED BY INVESTING ACTIVITIES (B)				(1,68,000)
	CASH FLOW FROM FINANCING ACTIVITIES
	Interest expense				(58,000)
	Dividend paid				(30,000)
	Bond paid				(20,000)
	Share issued				1,02,650
	NET CASH USED BY FINANCING ACTIVITIES (C)				(5,350)
	NET INCREASE IN CASH (A)+ (B) + (C)				19,250
	Cash at the beginning of the period				1,04,000
	CASH AT THE END OF THE PERIOD				1,23,250
CASHFLOW STATEMENT OF RIYADH STAR FOR THE YEAR ENDED 31ST DECEMBER 2019
(2)    INDIRECT METHOD
CASH FLOW FROM OPERATING ACTIVITIES									$
NET INCOME										52,000
Add: non cash expenses
Depreciation expense									60,000
Change in working capital
Decrease in inventory									40,000
Decrease in salary payable										(37,750)
Increase in prepaid expense										(40,000)
Decrease in accounts payable										(40,000)
Increase in interest payable										17,000
Decrease in Accounts receivable										83,350
Decrease in bond payable										(20,000 )
Income from financing activity
add :Interest expense										58,000
NET CASH PROVIDED BY OPERATING ACTIVITIES										1,72,600
CASH FLOW FROM INVESTING ACTIVITIES
EQUIPMENT PURCHASED									(1,68,000)
NET CASH USED BY INVESTING ACTIVITIES (B)									(1,68,000)
CASH FLOW FROM FINANCING ACTIVITIES
Interest expense									(58,000)
Dividend paid									(30,000)
Share issued									1,02,650
NET CASH USED BY FINANCING ACTIVITIES (C)									14,650
NET INCREASE IN CASH              (A) + (B) + (C)									19,250
Cash at the beginning of the period									1,04,000
CASH AT THE END OF THE PERIOD									1,23,250

	WORKINGS
1)	CASH RECEIVED FROM CUSTOMERS
	OPENING ACCOUNTS RECEIVABLES	1,83,350
ADD	SALES	12,55,250
LESS	CLOSING ACCOUNTS RECEIVABLE	1,00,000
		13,38,600
2)	SALARY PAID
	OPENING SALARY PAYABLE	94,000
ADD	CURRENT YEAR SALARY	2,03,945
LESS	CLOSING SALARY PAYABLE	56,250
		2,41,695
3)	DIVIDENT PAID
	RETAINED EARNINGS AT THE BEGINNING	1,78,000
ADD	CURRENT YEAR PROFIT	52,000
LESS	RETAINED EARNINGS AT THE END	2,00,000
		30,000
4)	PURCHASE
	COST OF GOODS SOLD	8,22,000
LESS	OPENING STOCK	2,50,000
ADD	CLOSING STOCK	2,10,000
		7,82,000
5)	CASH PAID TO SUPPLIERS
	OPENING ACCOUNTS PAYABLE	2,20,000
ADD	PURCHASE	7,82,000
LESS	CLOSING ACCOUNTS PAYABLE	1,80,000
		8,22,000
6)	INTEREST PAID
	OPENING INTEREST PAYABLE	20,000
ADD	CURRENT YEAR INTEREST	75,000
LESS	CLOSING INTEREST PAYABLE	37,000
		58,000
7)	ADDITIONAL EQUIPMENT PURCHASED
ADD	OPENINING BALANCE	5,84,650
ADD	PURCHASE	2,15,350
LESS	DEPRECIATION	60,000
LESS	CLOSING BALANCE	8,00,000
		-60,000
8)	PREPAID EXPENSE
	OPENING BALANCE	80,000
	CLOSING STOCK	1,20,000
		-40,000
9)	EQUIPMENT PURCHASED
	ADDITIONAL EQIPMENT PURCHASE	60,000
ADD	PURCHASE GIVEN IN QUESTION	2,15,350
LESS	EQUITY ISSED	1,07,350
		1,68,000
10)	BONUS PAID
ADD	OPENING BALANCE	3,20,000
LESS	CLOSING STOCK	3,00,000
		20,000
11)	SHARE ISSUED
ADD	CLOSING STOCK	5,80,000
LESS	ISSUED FOR QUIPMENT PURCHASED	1,07,350
LESS	OPENING BALANCE	3,70,000
		1,02,650

(3) Free cash flow measures the efficiency of a company in generating cash. It is used to measure whether a company have enough cash, after funding operations and capital expenditures, to pay dividends and share buybacks.

FREE CASH FLOW = OPERATING CASH FLOW – CAPITAL EXPENDITURE

In direct method,

= 192600-168000= 24600

In indirect method,

=172600-168000= 4600

Here the difference of 20000 is on account of the treatment bonus paid in both methods. In indirect method it is used for calculating the change in working capital assuming it to be a current liability whereas in direct method it is considered under financing activity not under fund from operation.