Statement of Cash Flow: Indirect Method

Introduction

This tutorial provides a comprehensive guide on preparing a Statement of Cash Flow using the indirect method. Understanding how to construct this financial statement is essential for analyzing a company's cash inflows and outflows, which can provide valuable insights into its overall financial health.

Step 1: Understand the Structure of the Statement of Cash Flow

The Statement of Cash Flow consists of three main sections:

1. Operating Activities: This section adjusts net income for changes in working capital and non-cash expenses.
2. Investing Activities: This part includes cash flows from the purchase and sale of physical and financial investments.
3. Financing Activities: Here, you account for cash flows related to borrowing, repaying debt, and equity transactions.

Practical Advice

• Familiarize yourself with these sections as they form the backbone of the cash flow statement.
• Ensure you have access to the company’s income statement and balance sheet to facilitate calculations.

Step 2: Start with Net Income

Begin the cash flow statement with the net income from the income statement. This figure serves as the starting point for the indirect method.

Practical Advice

• Make sure to use the most recent net income figure.
• Keep in mind that net income may include non-cash revenues and expenses.

Step 3: Adjust for Non-Cash Items

Adjust the net income for non-cash items such as:

• Depreciation and Amortization
• Deferred Taxes
• Unrealized Gains or Losses

Example of Adjustments

• If depreciation expense is $10,000, add this amount back to net income.

Step 4: Adjust for Changes in Working Capital

Analyze changes in current assets and liabilities to determine their impact on cash flow. Adjust for:

1. Increase in Current Assets: Subtract the increase (e.g., Accounts Receivable).
2. Decrease in Current Assets: Add the decrease.
3. Increase in Current Liabilities: Add the increase (e.g., Accounts Payable).
4. Decrease in Current Liabilities: Subtract the decrease.

Practical Advice

• Review the balance sheet to identify changes in working capital accounts.
• Document these changes clearly to avoid errors.

Step 5: Summarize Operating Activities

After making the necessary adjustments, summarize the total cash flow from operating activities. This figure is crucial as it reflects the cash generated or used by the core operations of the business.

Step 6: Report Investing Activities

Next, include cash flows from investing activities. This typically covers:

• Cash paid for purchasing property, plant, and equipment.
• Cash received from the sale of investments.

Practical Advice

• Keep accurate records of all investment transactions to ensure completeness.

Step 7: Detail Financing Activities

Finally, outline financing activities, including:

• Cash received from issuing stock or bonds.
• Cash paid for dividends or repaying debt.

Practical Advice

• Verify all transactions related to financing to capture the complete cash flow impact.

Conclusion

In summary, preparing a Statement of Cash Flow using the indirect method involves starting with net income, making adjustments for non-cash items and changes in working capital, and detailing cash flows from investing and financing activities. This structured approach helps provide a clear picture of a company's cash situation, essential for making informed financial decisions. Next, consider practicing with real financial statements to enhance your understanding and proficiency in cash flow analysis.