Chapter 14, Problem 13P

To determine

Operating Cash Flow: Operating Cash Flow is the type of cash flow where the cash is given or received in the course of routine business operations of the company.

Free Cash Flow: Free cash flow is the amount that remains in the company which helps to operate it in a planned way after deducting the funds from the company.

Determine the total cash flow, operating cash flow and free flow cash flow of Rusco Company and determine the reason for a decline in the total cash balance.

Answer to Problem 13P

Solution: The total cash flow of Rusco Company show a net decrease of $13000, cash flow from operating activities shows a net decrease of $11000 and a net decrease of $141000 is registered in the free flow cash flow.

Negative free cash flow suggests that the company has not provided enough to its operating expenditure and has over incurred the capital expenditure.

Explanation of Solution

The operating cash flows and total cash flows are shown as under −

Particulars	Amount ($)
CASH FLOW FROM OPERATING ACTIVITIES
Net Profit before tax	30,000
Adjustment for Non-cash items / items
Loss on sale land	2,000
Gain on sale of investments	(10,000)
Operating Profit before change in working capital	22,000
Cash flow from operations before working capital changes
Increase / (Decrease) in Current Liabilities and Current Assets:
Accounts payable	63,000
Accumulated depreciation	11,000
Accrued Liabilities	(9,000)
Income Taxes Payable	8,000
Inventory	(50,000)
Prepaid Expenses	4,000
Accounts receivable	(40,000)
Cash flow from operations after working capital changes	9,000
Income Taxes paid	(20,000)
Net Cash Flow from Operating Activities	(11,000)
CASH FLOW FROM INVESTING ACTIVITIES
Property Plant and Equipment	(1,30,000)
Sale of Equipment	8,000
Sale of Long term Investments	30,000
Net Cash Flow from Investing Activities	(92,000)
CASH FLOW FROM FINANCING ACTIVITIES
Bonds payable	70,000
Common Stock	20,000
Dividend paid	-
Net Cash Flow from Financing Activities	90,000
Net Increase/ (Decrease) in Cash and Cash Equivalents	(13,000)
Opening Cash & Cash Equivalents	21,000
Closing Cash & Cash Equivalents	8,000

Steps to calculate the operating cash flow:

• The non −cash items like depreciation charged to Profit and loss statement (and not the accumulated depreciation), provisions for bad debts are first added to the net income earned by the entity which gives the operating profit before it changes in working capital.
• The operating profit is then adjusted as per the changes in the working capital that is increase/decrease in current assets and current liabilities of the business. This gives the cash flow from operating activities after the working capital changes.
• Direct taxes actually paid (and not just provided for) are then deducted from the cash flow from operations after working capital changes and this gives the net cash flow from operating activities.

Steps to calculate the investing cash flow:

Investing Cash Flow is one where there is a change in the capital structure of the company. These are usually made in the events of amalgamations, reconstructions, demergers and related events where the whole capital structure of the company is restructured. Hence, purchase of common stock or the purchase of an asset which are all long term investments made with the purpose of reaping long term benefits are termed as investing cash flows.

• The purchase of property, plant, equipment, land or any other tangible fixed asset is deducted from the total cash flows.
• The sale of property, plant, equipment, land or any other tangible fixed asset or investment or an asset held for reaping long term benefits is added to the total cash flows.

Steps to calculate financing cash flow:

Financial cash flows, as the name suggests, relate to the financial inflow and outflow of business. Repayment of debt, payment of interest and dividends are thus classified as financial cash flows.

It mainly relates to the inflow and outflow of the funds of the business and payment to the investors of long term capital in the company.

• The addition to the capital base of the company like purchase or buy-back of common stock, new loan taken, debt borrowed are added to the total cash flows.
• The repayment of debt or loan, sale of common stock, reduction in equity are deducted from the total cash flows.
• Financial interest or dividend paid are also considered as financing activities and are thus deducted from the total cash flows when paid by the company.

The free flow cash flow is as under −

Particulars	Amount ($)
Cash Flow from Operating Activities	(11,000)
Purchase of Property, Plant and Equipment	(1,30,000)
Free Cash Flow	(1,41,000)

The major reasons for decline in cash balances are as under-

• Unnecessary purchase of property, plant and equipments due to a lack of planning
• Increase in accounts receivables since cash was not timely recovered from debtors
• Increase in inventory resulting in huge non-moving stocks

Conclusion

The operating cash flow, the total cash flow and the free flow cash flows are thus calculated.