Decrease in operating assets (source of cash) should be added and increase in operating assets (use of cash) should be subtracted.Add or subtract changes to related balance sheet operating accounts.Subtract any gains that resulted from financing or investing cash flows (For example, gain on the sale of an equipment).Add back all non-cash charges to income and subtract all non-cash components of revenue (For example, add depreciation and amortization).Indirect method shows how cash flow from operations can be obtained from reported net income as a result of a series of adjustments. This is a liability and increase in liability is source of cash so +ve adjustment.Ĭash paid for inputs = – $20 million – $4 million + $2 million = – $22 million This is an asset and increase in asset is use of cash so –ve adjustment. During this period inventory increased by $4 million and accounts payable went up by $2 million. This is a liability and increase in liability is source of cash so +ve adjustment.Ĭash collected from customers = + $10 million – $2million + $1million = $9 million.Ĭonsider a company with COGS of $20 million for a particular period. Unearned revenue went up from $1 million to $2 million. Accounts receivable for the year went up from $2 million to $4 million. Increase in liability is source of cash (+ve adjustment) and decrease in liability is use of cash (-ve adjustment).Ĭash collected from customers: Adjust sales for changes in accounts receivable and unearned revenue.Ĭash for inputs: Adjust COGS for changes in inventory and accounts payable.Ĭash operating expenses: Adjust SG&A for changes in related accrued liabilities or prepaid expenses.Ĭash interest paid: Adjust interest expense for changes in interest payable.Ĭash taxes paid: Adjust tax expense for changes in tax payable and changes in deferred tax assets and liabilities.Ĭonsider a company that reported sales of $10 million.Increase in assets is use of cash (-ve adjustment) and decrease in asset is source of cash (+ve adjustment).In the direct method, we take each item from the income statement and convert it to its cash equivalent by removing the impact of accrual accounting. Presentation of cash flow from investing activities and cash flow from financing activities is the same under both methods. Only cash flow from operating activities is presented differently under the two methods. ![]() This example clearly shows that receivables (balance sheet item), revenue (income statement item) and cash collected from customers (cash flow item) are related as follows:Įnding receivables = Beginning receivables + Revenue – Cash collected from customers 10 – 14: Preparing the Cash Flow Statement
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