indirect method cash flow statement

  

Definition

Begins with the net income figure taken from the income statement (profit and loss account) and then makes several adjustments which fall under three main headings: (1) Expenses not involving cash outflows such as depreciation, deferred taxes, increased accounts payable which are added back; (2) Cash outflows not recorded as expenses such as increases in inventory which are subtracted; and (3) Revenues not involving cash inflows such as increased accounts receivable, profit on sale of property which are subtracted. These adjustments convert the net income into net cash-flow from operating activities. To this amount cash inflows from investing activities and financing activities are added and related cash outflows are deducted. The resulting figure gives the cash balance at the end of the period for which the statement was prepared. While this method is more complex, over 95 percent of firms prefer it over the direct method (see direct method cash flow statement) because it shows the relationship between the two other critical financial statements-balance sheet and income statement. Also, it avoids the duplication of effort where a supplementary schedule to reconcile net income with cash-flows from operating activities is needed. However, it does not disclose operating cash receipts and payments. It is called 'indirect' because it proceeds from the net income (instead of with the actual cash receipts and disbursements) which is adjusted to reconcile it with the net cash flow. See also adjusted net income approach.

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