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Solution 15.2
Net debt is as per
the definitions in FRS 1 “the borrowings of the entity less cash and
liquid resources”. If cash and liquid resources exceed debt then
the term used becomes Net Funds.
Cash flows from operating activities are the cash effects of transactions relating to the operating or trading activities of the business (the normal trading activities of the business, not capital activities). Operating cash flows will be concerned with: · cash collected from customers · cash paid to trade creditors for purchases · cash paid to staff /PAYE/PRSI · cash paid for services (overheads) Operating profit is the profit before interest and tax achieved by a business from its main trading activities. It is the sales of a business less all the operating expenses including cost of sales, administration, selling, distribution and depreciation expenses.
The main reasons
for differences between operating cash flow and operating profit are that
operating profit is the difference between revenues earned and expenses
charged whereas operating cash flow is the difference between revenues
received and expenses paid. Also operating profit includes non cash items
such as depreciation in its calculation.
1. The Direct Method. Under this method we gather the information from a detailed cashbook, collections from customers, and cash paid to suppliers, staff, and overheads. Calculation of operating cash flow - The Direct method
The direct method highlights the operating cash figure, which is the cash figure generated from normal activities before interest and other non-trading cash movements.
2. The Indirect Method In this format we are adjusting the operating profit figure (net profit before interest and tax) back to an operating cash figure. This is calculated as follows.
· Depreciation · Provision for bad debts · Profits or losses on the sale of fixed asset These items are all categorised as ‘non-cash’. In other words they do not give rise to a cash transaction/movement and would not appear in the cash/bank account. If these items have reduced the operating profit (if they were expenses) then to adjust for them we need to add them back to operating profit. If they had the effect of increasing profit then we deduct them from operating profit. 2. Adjust the operating profit for changes in stocks, debtors, prepayments, accruals and creditors. Changes in the above working capital items causes differences between figures in the profit and loss account and figures in the cash/bank account. For example a business generated sales of €10,000 during the year. If debtors at the
Calculation of Operating cash flow - Indirect method
The operating cash
flow is €32,060 whether we use the direct or indirect method. Ultimately
the indirect method outlines for us some of the main reasons for differences
between the net profit figure and the net cash flow figure and must be
shown as a note to the cash flow statement
Operating profit is the profit before interest and tax achieved by a business from its main trading activities. It is the sales of a business less all the operating expenses including cost of sales, administration, selling, distribution and depreciation expenses. Overall cash flow is the movement in cash for the business as a whole over a defined period. It includes operating cash flow as well as other cash movements such as financing, receipts or expenditure on fixed assets, corporation tax payments, dividend payments, other investment returns, servicing of debt costs, cash from the investment or disposal of liquid assets and the acquisition or disposal of other business entities.
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