A:

Cash flow from operating activities can be calculated directly or indirectly. Either way, cash from operating activities represents the inflows and outflows of cash resulting from a company's primary business activities.

What Is Operating Cash Flow?

Operating cash flow is cash that is generated from the normal operating processes of a business. Each business produces a cash flow statement comprised of cash flows from financing, investing and operating activities. These are segregated so that analysts develop a clear idea of all the cash flows generated by a company’s various activities.

Operating cash flow provides the analyst with insight into the stability of the core of the business. A company that does not have a positive cash flow from its primary operations will likely be unable to remain solvent.

The cash from operating activities is a reference to the cash inflows and outflows that come from a company's main business activities, such as the purchase and sale of its products or the provision of services. Cash flow from operating activities excludes money that is spent on capital expenditures, cash directed to long-term investments and any cash received from the sale of long-term assets. Also excluded is the amount that is paid out as dividends to stockholders, amounts received through the issuance of bonds and stock, and money used to redeem bonds.

Direct Method for Calculating Cash Flow From Operating Activities

To calculate operating cash flow using the direct method, the various types of cash payments and receipts must first be determined. This includes cash paid to suppliers, cash receipts from customers and cash paid out in salaries. These figures are calculated by using the beginning and end balances of a variety of a business accounts and examining the net decrease or increase of the account.

The exact formula used to calculate the inflows and outflows of the various accounts differs based on the type of account. In the most commonly used formulas, accounts receivable are used only for credit sales and all sales are done on credit. If cash sales have also occurred, receipts from cash sales must also be included to develop an accurate figure of cash flow from operating activities.

Indirect Method for Calculating Cash Flow From Operating Activities

Using the indirect method, a company's net income figure, as listed on its income statement, is used as the basis for determining the amount of net cash flow from operating activities. Because a company’s income statement is prepared on an accrual basis, revenue is only recognized when it is earned and not when it is received.

In this way, net income is not a perfectly accurate representation of net cash flow from operating activities. It becomes necessary to adjust earnings before interest and taxes (EBIT) for items that affect net income, even though no actual cash has yet been received or paid against them.

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