cash generated from operations

[sstudent]

Hello everybody,

student here and in need of some answers please.

Im going though the cash flows statement chapter and something is bugging me when it comes to the calculation of the cash generated from operations.

my question is:
Why are not expenses (wages, stationary, electricity, rent) which are deducted fro Gross profit in the income statement and so affects the level of profit before tax, not added back to the profit before tax when calculating cash generated from operations?I ask because Depreciation charge for the period is added to the profit before tax in the calculation for cash generated from operations. why aren't other expenses treated the same?

I hope my question is clear since i know being a student i may sound confusing because i am confused.

thank you

 

[Fidget]

It's ok - cash flow statements can be really tricky to get your head around because you're used to thinking accruals rather than right now cash coming in and going out of the business bank account.

But anyway, other expenses such as wages, utility bills, stationery etc are all genuine cash flows at the time the cash flow is done.

Depreciation is added back because it is a non cash item. The cash flow happened when the asset being depreciated was purchased - no cash goes out of the business bank account because of depreciation.

Gains/losses on disposal are another example of non cash items added back/deducted from operating profit when drawing up your cash flow.

 

[sstudent]

Thanks for your reply Fidget,

I regret to say that i am not with you yet.I think i am close though.


Are you saying that in order for the cash to be generated from operations all expenditure that needs to happen like wages, utilities is not considered in the cash flow statement?
in other words only elements which are outside of 'production' are either deducted or added back.

but then again, payables which include raw materials are taken into account.
.....and i get lost again

thanks again for your patience

 

[Fidget]

I'm saying that you only include real cash flows in your cash flow statement. Payments of wages, utilities etc are all real cash flows. You have to think about money coming in and money going out of the bank account when it comes to cash flows.

Depreciation is not a cash flow. No money went out of the business bank account because of depreciation, so it's what we call a 'non-cash' item in the P&L and therefore has to be added back to profit/(loss) from operating activities when drawing up the cash flow statement.

The cost of the item being depreciated would've been in the cash flow statement at the time it was paid for and under the 'investing activities' header probably in the cash flow statement.