In preparing the cash flows from operating activities section under the indirect method, you start with net income per the income statement, reverse out entries to income and expense accounts that do not involve a cash movement, and show the change in net working capital. Entries that affect net income but do not represent cash flows could include income you have earned but not yet received, amortization of prepaid expenses, accrued expenses, and depreciation or amortization. Under this method you are basically analyzing your income and expense accounts, and working capital. The following is an example of how the indirect method would be presented on the cash flow statement:
- Net income per the income statement
- Minus entries to income accounts that do not represent cash flows
- Plus entries to expense accounts that do not represent cash flows
- Equals cash flows before movements in working capital
- Plus or minus the change in working
capital, as follows:
- An increase in current assets (excluding cash and cash equivalents) would be shown as a negative figure because cash was spent or converted into other current assets, thereby reducing the cash balance.
- A decrease in current assets would be shown as a positive figure, because other current assets were converted into cash.
- An increase in current liabilities (excluding short-term debt which would be reported in the financing activities section) would be shown as a positive figure since more liabilities mean that less cash was spent.
- A decrease in current liabilities would be shown as a negative figure, because cash was spent in order to reduce liabilities.
The net effect of the above would then be reported as cash provided by (used in) operating activities.
The cash flows from investing activities and financing activities would be presented the same way as under the direct method.