Example of Cash Flow Statement Using the Direct Approach or Direct Method (continued)
Cash Used For Operations
The ability of an organization to fund all costs related to its operations, using actual cash collected from revenues earned during the period, indicates a capacity for cost recovery. This can be determined by presenting the reductions made against the cash collected from operation, which includes:
Purchases – Find this amount in the income statement as part of the Cost of Goods Sold presentation.
Operating Expenses – Find this amount also in the income statement but captioned as “Sub-total Operating Expenses". Depreciation expense has been excluded because it is a non-cash item and therefore has no effect on the cash balance.
Payment of Liabilities – Look for this amount in the balance sheet and, again, take note that the decrease or the difference between the beginning and end balance was used. A decrease denotes payment of obligations related to business activities.
If the difference is an increase, this means that some of the expenses incurred for the operations are yet unpaid. Although we cannot pinpoint whether the unpaid liability relates to purchases or operating expenses, the amount will simply be taken as an adjustment of the cash usage.
After which, the total of these three components is captioned as "Total Cash Used for Operations". However, if any adjustments are made, use the title “Net Cash Used for Operations “.
Subtract the Total Cash Used for Operations from the Total Cash Collections to determine how much of the cash generated from the business operations remains intact. The amount will have a positive effect on the entity’s cash balance.
If the amount of total cash utilized is higher than the total collection, the negative effect reduces the cash balance and will indicate that the business did not generate enough funds to allow for total cost recovery.