I. Sales plus or minus the change in A/R equals cash from sales II. Less: cost of goods sold*, or cost of sales,* plus-or-minus changes in inventory and payables, to arrive at cash production (or acquisition) costs. These in turn are subtracted from your cash-fromsales figure to get gross cash margins.

III. Next, adjust SG&A expense* for plus-and-minus changes in prepaid assets and accrued expenses to get cash operating expense. IV. Gross cash margins (from Step II) less cash operating expense
(from Step III) leaves cash from operations.

V. Now adjust for all miscellaneous-category pluses and minuses as appropriate to get the net change in all of the other categories: other income and expense, changes in other assets and other
liabilities. Cumulatively call this miscellaneous cash income (or expense).

VI. Then come income taxes: provision for taxes from the income statement is adjusted for all plus-and-minus changes in balance- sheet accounts that are income-tax related to arrive at cash taxes paid.

Summarizing: Cash from operations (Step IV), plus or minus miscellaneous cash income (Step V), plus or minus cash taxes paid (Step VI) leaves net cash from operations.

At this point you have net cash from operations, but what you don’t yet have is cash from financing and cash from investing.

These three categories of cash flow—operating, financing and investing—are what the American Institute of CPAs (AICPA) requires as part of its directive on the subject of cash flow. So far, you have gotten only to the operating level; now you can proceed to the remaining two categories. You will do it in a way that creates some of the key summary lines that both you and your banker will need to know.

VII. Net cash income is calculated from net cash from operations at step six and adjusted, plus and minus, for interest and dividend expenses. It is adjusted as well for changes in related balancesheet
accounts such as interest payable and dividends payable.

Taken From : Cash Rules