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Lecture 3
Lecture 3
Direct Method
• Under the direct method, cash line item of the accrual-based
income statement is converted into cash receipts or cash
payments
• A simple way to express this, the direct method converts an
accrual basis income statement into cash basis income
statement
Indirect Method
Indirect method of presenting operating cash flow
• Net income xxx
Adjustments to reconcile net income to cash flow Provided by
operating activities
Depreciating and amortization xxx
• Deferred income taxes xxx
• Increase in accounting receivable (xxx)
• Increase in inventory (xxx)
• Decrease in prepaid expenses xxx
• Increase in accounts payable xxx
• Increase in accrued liabilities xxx
• Operating cash flow xxx
How the cash flow statement is linked to the income
statement and balance sheet
Operating cash flow
+ Investing cash flow
+Financing cash flow
=Change in cash balance
+Beginning cash balance
=Ending cash balance
Direct Method
• The direct method of present a firm’s statement of cashflows
only cash payments and cash receipts over the period. The
sum of these inflows and outflows is the company’s CFO.
• The following are common components of cash flow that
appear on a statement of cash flow presented under the
direct method
• Cash collected from customers, typically the main
component of CFO
• Cash used in the production of goods and services (cash
inputs)
• Cash operating expenses
• Cash paid for interest
• Cash paid for taxes
Direct Method
• Formulas need to remember If assets were sold during the
period then following formula will be used
• Cash paid for new asset=ending gross assets+ gross cost of
old assets sold – beginning gross assets
• When calculating the cash flow from an asset that has been
sold, it is necessary to consider the any gain or loss from the
sale using the following formula
• Cash from asset sold= book value of the asset +gain (or
loss) on sale
Indirect Method
• Begin with net income
• Subtract gains or add losses that resulted from financing or
investing cash flows (such as gain from sale of land)
• Add back all non cash charges to income (such as
depreciation and amortization) and subtract all non cash
components of revenue
• Add or subtract changes to balance sheet operating
accounts as follows