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Hallo,
In the following example, is to find the cash generated from operations:
cash sales
profit before tax
increase in receivables
decrease in payables
inventory at start of period
inventory at end of period– in the solution the profit before tax and the inventory at start and end of period are excluded to come to the final answer, so only cash sales, increase in Rs, and decrease in Ps are taken into account. Could you explain why?
Thank you!
I am sorry, but I do not understand what you are asking.
Can you type out the full question and then I will try and explain.Hallo,
Yes, the question is:
What amount of cash is generated from operations?
and they list the following:
cash sales
profit before tax
increase in receivables
decrease in payables
inventory at start of period
inventory at end of periodBut, the final answer does not include the profit before tax, neither the difference between the inventory at start and end of period,
i.e. the answer is = cash sales – increase in receivables – decrease in payables,
so the profit before tax and inventories is not taken into account in the solution, why is it so?Thank you!
If the question is typed exactly the way that you have typed it (with no numbers), then both the question and the answer make no sense at all.
I don’t know which book you found the question in, but I cannot help!
Hallo,
sorry, I have the numbers, here they are:
cash sales 13,780
profit before tax 25,600
increase in receivables 18600
increase in payables 14080
inventory at start of period 11700
inventory at end of period 12560Answer: 13780 – 18600 +14080 = 9260 this is the cash generated from operations
Question: why profit before tax and inventory (beg & end) are not part of the answer?
Thank you!
The correct answer is 20,220.
The answer is nonsense – I don’t know which book you got it from, but it is wrong.
Hallo,
I am coming back to this example. I didn’t want to copy all of the example, as it seems long, and I shortened it, but here is the full text:
The following information has been extracted from the accounting records of Potter, a
company:
$
Cash sales 13,780
Profit before tax 25,600
Receivables at start of period 10,540
Receivables at end of period 29,140
Credit sales 164,300
Payables at start of period 9,380
Payables at end of period 23,460
Credit purchases 81,290
Inventory at start of period 11,700
Inventory at end of period 12,560
Expenses paid in cash 18,230
Amounts paid to staff 45,000What amount of cash is generated from operations? 29,040
The question I am asking myself, is why when coming to the answer of 29,040, the author doesn’t not take into consideration profit before tax and inventory (beg & end), these are not used when coming to the answer of 29,040 and I don’t understand why?
I hope this will be clearer, if not, then there’s really a mistake in the text.
Thank you!
Thank you for typing the whole question.
The answer is correct, and now I can explain why 🙂It is because they have had to use the direct method (which you will know about from the chapter in our Course Notes). Usually, we use the indirect method and start with the profit before interest and tax. However here there is not enough information because we are not told the depreciation (or the interest).
The cash received from credit customers is 10540 + 164300 – 29140 = 145700.
The cash from cash sales is 13780.
So the total cash from customers is 145700 + 13780 = 159480The cash to suppliers is 9380 + 81290 – 23460 = 67210
The cash to employees is 45000
The cash for other expenses is 18230So the cash generated from operation is 159480 – 67210 – 45000 – 18230 = 29040.
I hope that is now clear 🙂
Hallo,
I understand the solution.
I am wondering what is the explanation that inventory is not part of the direct method?
And, one question which is not related to this example, but to the indirect method, and my questions relate to the lines with a number and a star:
1* Profit before taxation after interest 80,000
Depreciation and amortisation charges 20,000
2* Interest charges in the income statement 2,300
Gains on disposal of non?current assets (6,000)
Losses on disposal of non?current assets 4,500
Increase in trade and other receivables (7,000)
Decrease in inventories 2,000
Increase in trade payables 3,000
Cash generated from operations 98,800
Taxation paid (tax on profits) (21,000)
4* Interest charges paid (2,500)
Net cash flow from operating activities 75,3001* Profit before taxation after interest 80,000
– why the profit is before taxation but after interest, and why do we subtract interest in 4* again, i.e. twice, is it for the end period?
2* Interest charges in the income statement 2,300
– is this interest we have received, as it is added?
4* Interest charges paid (2,500)
– this is the same meaning as in 1* but for different period, or?Am I asking correctly my doubts, otherwise I will try to explain it again.
Thank you!
The reason that the profit is before taxation and after interest is because the question says it is 🙂
This is a cash flow statement, and so we need to add back the interest actually charged in the Statement of profit or loss, and then subtract the interest that was actually paid.
The two are not necessarily the same (and they are not the same here).
In calculating the profit for the year they will have used the interest expense for the year – whether it has been paid or whether it is still owing.
For the Statement of cash flows we are only interested in how much interest was actually paid.
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