Read the following information to answer.
On the basis of case study given below, answer the question which follows:
"Mikku, an alumnus of IIT Delhi, initiated his start-up "Gajanan Ltd." in the year 2016. His profit in the year 2020-21 after all appropriation was ₹6,25,000. This profit was arrived at after taking the following items into consideration (income tax paid during the year was equal to the provision for tax):
| Loss on Sale of fixed Assets | ₹5,00,000 |
| Goodwill written off | ₹3,80,000 |
| Transfer to reserve | ₹3,55,000 |
| Provision for tax | ₹2,70,000 |
| Interest on Debentures paid | ₹1,65,000 |
| Particulars | 2020(₹) | 2021(₹) |
| Prepaid Expenses | 25,000 | 10,000 |
| Accrued interest | 40,000 | 68,000 |
| Trade payables | 7,00,000 | 4,00,000 |
| Inventories | 6,50,000 | 5,50,000 |
Cash from operating activities before tax will be:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → ₹20,82,000
Cash from operating activities before tax is the operating profit before working capital changes, adjusted for the changes in current assets and current liabilities. A decrease in a current asset or an increase in a current liability releases cash and is added; an increase in a current asset or a decrease in a current liability uses cash and is deducted.
Net profit before tax
₹6,25,000 + ₹3,55,000 (transfer to reserve) + ₹2,70,000 (provision for tax) = ₹12,50,000
Operating profit before working capital changes
₹12,50,000 + ₹5,00,000 (loss on sale of fixed assets) + ₹3,80,000 (goodwill written off) + ₹1,65,000 (interest on debentures) = ₹22,95,000
Working capital changes
Add: Decrease in prepaid expenses = ₹15,000
Less: Increase in accrued interest = ₹28,000
Less: Decrease in trade payables = ₹3,00,000
Add: Decrease in inventories = ₹1,00,000
Cash from operating activities before tax = ₹22,95,000 + ₹15,000 − ₹28,000 − ₹3,00,000 + ₹1,00,000 = ₹20,82,000
The fall in trade payables is the item most often added by mistake: paying off creditors uses cash, so it is deducted.