Ascertaining Cash Flow from Operating Activities

Operating activities are the primary revenue-generating activities of a business — the core operations that bring in cash and consume cash. Because these flows are central to a company's health, AS-3 (Accounting Standard 3) requires special care in their calculation. The standard gives two methods for reporting cash flows from operating activities: the Direct method and the Indirect method.

The Two Methods

Direct method — This shows the major classes of gross cash receipts (e.g., cash received from customers) and gross cash payments (e.g., cash paid to suppliers and employees). It gives a clear picture of where cash actually came from and went, which is useful for estimating future cash flows. However, most companies do not use it because the information is not readily available from accrual-based accounting records.

Indirect method — This starts with the net profit or loss (before tax and extraordinary items) as reported in the Statement of Profit and Loss. That profit figure is then adjusted for three types of effects:

1. Transactions of a non-cash nature (e.g., depreciation, amortisation, provisions).
2. Deferrals or accruals of past or future operating cash receipts or payments (e.g., changes in debtors, creditors, inventory).
3. Items of income or expense that relate to investing or financing activities (e.g., profit on sale of a fixed asset, interest income, dividend income).

In practice, the indirect method is far more common. This chapter follows the indirect method.

Treatment of Proposed Dividend

Proposed dividend is a special item that appears in the Notes to Accounts as a contingent liability. It becomes an actual liability only after it is declared (approved) by shareholders at the Annual General Meeting. Until then, it is not recorded in the books.

Here is the accounting treatment step by step:

• The previous year's proposed dividend is declared (approved) in the current year's Annual General Meeting.
• Once declared, it is debited to Surplus (i.e., Balance in Statement of Profit and Loss) and credited to Dividend Payable.
• The declared dividend must be paid within 30 days, so it is usually paid within the same financial year.

Impact on the Cash Flow Statement (Indirect Method):

| Step | Treatment |

|------|-----------| …