Cash flow statement indirect method
/What is the Cash Flow Statement Indirect Method?
The indirect method for the preparation of the statement of cash flows involves the adjustment of net income with changes in balance sheet accounts to arrive at the amount of cash generated by operating activities. The statement of cash flows is one of the components of a company's set of financial statements, and is used to reveal the sources and uses of cash by a business. It presents information about cash generated from operations and the effects of various changes in the balance sheet on a company's cash position.
The format of the indirect method appears in the following example. In the presentation format, cash flows are divided into the following general classifications:
The indirect method of presentation is very popular, because the information required for it is relatively easily assembled from the accounts that a business normally maintains in its chart of accounts. The indirect method is less favored by the standard-setting bodies, since it does not give a clear view of how cash flows through a business. The alternative reporting method is the direct method.
Cash Flow Statement Indirect Method vs. Direct Method
Under the indirect method, the calculation of cash flows from operating activities begins with net income, which is then adjusted for changes in balance sheet accounts to arrive at the amount of cash generated or lost by operating activities. Under the direct method, actual cash flows are presented for items that affect cash flow. Examples of the items that are usually presented under this approach are cash collected from customers, interest and dividends received, cash paid to employees, cash paid to suppliers, interest paid, and income taxes paid. The difference between these methods lies in the presentation of information within the cash flows from operating activities section of the statement. There are no presentation differences between the methods in the other two sections of the statement, which are the cash flows from investing activities and cash flows from financing activities.
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Example of the Statement of Cash Flows Indirect Method
For example, Lowry Locomotion constructs the following statement of cash flows using the indirect method:
Lowry Locomotion
Statement of Cash Flows
for the year ended 12/31x1
| Cash flows from operating activities | ||
| Net income | $3,000,000 | |
| Adjustments for: | ||
| Depreciation and amortization | $125,000 | |
| Provision for losses on accounts receivable | 20,000 | |
| Gain on sale of facility | (65,000) | |
| 80,000 | ||
| Increase in trade receivables | (250,000) | |
| Decrease in inventories | 325,000 | |
| Decrease in trade payables | (50,000) | |
| 25,000 | ||
| Cash generated from operations | 3,105,000 | |
| Cash flows from investing activities | ||
| Purchase of property, plant, and equipment | (500,000) | |
| Proceeds from sale of equipment | 35,000 | |
| Net cash used in investing activities | (465,000) | |
| Cash flows from financing activities | ||
| Proceeds from issue of common stock | 150,000 | |
| Proceeds from issuance of long-term debt | 175,000 | |
| Dividends paid | (45,000) | |
| Net cash used in financing activities | 280,000 | |
| Net increase in cash and cash equivalents | 2,920,000 | |
| Cash and cash equivalents at beginning of period | 2,080,000 | |
| Cash and cash equivalents at end of period | $5,000,000 |