Question

Given an income statement for a company for a given year, how would you estimate operating cash flow for that given year? explain in detail

Answer 1

Operating activities are the normal business transactions pertaining to purchase and sale of goods and services. Cashflow from operating activities is calculated by taking the profit and loss as shown in P&L account and by making adjustments for non cash and non operating transactions and by adjusting the working capital changes.

Cash flow from operating activities can be calculated as below -

Cashflow from Operating activities :
Net profit before taxes, dividends, provisions and reserve	XX
Adjustment for non cash and non operating activities:
Add: Depreciation
Add: Loss on sale of fixed assets
Add: Interest paid
Add: Goodwill written , bad-debts written off
Less: Gain on sale of fixed assets
Less: Interest received
Less: Dividend received
By adding or substracting these non cash or non operating activities, we get - Operating profit before working capital changes	X
Adjustments for working capital changes:
Add: Decrease in current assets and Increase in current liabilities
Less: Increase in current assets and decrease in current liabilities
After making working capital adjustments, we get cash generated from operating activities	X
Less: Tax paid
Net cashflow from operating activities	X

We will start with the net profit before tax and if any deduction is made in current year for transferring to reserves, dividend, provision, it will be added back.

Then Adjustment will be made for non cash and non operating activities as these transactions must have reduced profit but these are either non cash items or are not operating activities.

After that adjustment will be made for working capital changes, we will get cash generated from operating activities.

After deducting tax paid in current year, net cashflow from operating activities will be calculated.

hope it helps!