How to Craft a Cash Flow Statement- A Step-by-Step Guide Using the Indirect Method_1
How to Prepare Cash Flow Statement Using Indirect Method
The cash flow statement is a crucial financial statement that provides insights into a company’s cash inflows and outflows over a specific period. It helps investors, creditors, and management understand the liquidity and financial health of a business. One of the most common methods used to prepare the cash flow statement is the indirect method. This article will guide you through the steps to prepare a cash flow statement using the indirect method.
Understanding the Indirect Method
The indirect method starts with the net income from the income statement and adjusts it for non-cash items and changes in working capital. This method is called “indirect” because it indirectly calculates cash flows from operating activities by adjusting net income. The indirect method is preferred by many because it is simpler and more intuitive than the direct method.
Steps to Prepare a Cash Flow Statement Using the Indirect Method
1. Start with Net Income: Begin by locating the net income figure from the income statement. This is typically found at the bottom of the income statement.
2. Adjust for Non-Cash Items: Identify and add back non-cash expenses, such as depreciation and amortization. These expenses do not involve actual cash outflows but are necessary for calculating net income.
3. Adjust for Changes in Working Capital: Analyze changes in working capital accounts, such as accounts receivable, accounts payable, and inventory. If there is an increase in accounts receivable, it means cash has not been received yet, so you would subtract this amount. Conversely, if there is a decrease in accounts receivable, it means cash has been received, so you would add this amount.
4. Consider Changes in Other Current Assets and Liabilities: Look for changes in other current assets and liabilities, such as cash and cash equivalents, short-term investments, and short-term debt. Adjust the net income accordingly.
5. Calculate Cash Flow from Operating Activities: Sum up all the adjustments to arrive at the net cash provided by operating activities. This figure represents the cash generated from the company’s core business operations.
6. Prepare the Cash Flow from Investing and Financing Activities: Similar to the operating activities, identify cash inflows and outflows from investing and financing activities. This includes cash received from the sale of assets, cash paid for the purchase of assets, cash received from issuing debt, and cash paid for dividends.
7. Calculate the Net Increase or Decrease in Cash: Add the cash flow from operating, investing, and financing activities to determine the net increase or decrease in cash for the period.
8. Close the Statement: Finally, adjust the opening cash balance with the net increase or decrease in cash to arrive at the closing cash balance.
Conclusion
Preparing a cash flow statement using the indirect method is a straightforward process that provides valuable insights into a company’s cash position. By following these steps, you can ensure that your cash flow statement accurately reflects the cash inflows and outflows of your business. Remember, a well-prepared cash flow statement can help you make informed decisions and maintain a healthy financial position.
