The cash flow statement direct method is based on cash receipts and cash payments. Bookkeeping systems are not designed to easily access this information in the format required and cash flow direct method formulas are required to compute receipts from sales, interest and dividends and payments for expenses, interest and income tax.
Operating working capital is the difference between current assets and current liabilities used in the day to day trading operations of a business. In most businesses this amounts to inventory plus accounts receivable less accounts payable, which represents the funding needed to buy inventory and provide credit to customers, reduced by the amount of credit obtained from suppliers.
Any net change in inventory, accounts receivable or accounts payable over an accounting period, results in a corresponding net change in business working capital. As the other side of the entry has to be represented by cash, the change in working capital represents a cash flow which is included as part of the cash flow statement.
In order to manage its cash flow a business needs to understand the working capital calculation. Working capital is the amount of cash needed to fund the normal day to day trading operations of the business. In a simple business it would be calculated as Inventory + Accounts receivable – Accounts payable representing the funding needed to buy inventory and provide credit to customers reduced by the amount of credit obtained from suppliers.
The net cash flow in or out for a business for an accounting period must be matched by changes in cash flow funding.
If we use the example cash flow statement below, the top half of the cash flow statement shows the cash flows in and out due to operating. financing and investing activities the final figure (highlighted in green) represents the net cash flow out of the business, in this case £57,000. In order for this to happen, the business must match this cash flow out with additional funding.