Net cash flow from operating activities – indirect versus direct method
Net cash flow from operating activities – indirect versus direct method
(1) Indirect method: Add back or deduct from net income those items that had no effect on cash.
1) Additions:
• Depreciation of tangible fixed assets
• Amortization of intangibles
• Amortization of deferred charges
• Amortization of bond discount
• Decrease in receivables
• Decrease in inventories
• Decrease in prepaid expenses
• Increase in payables
• Increase in accrued expenses
• Increase in deferred income tax liabilities
• Loss on sales of plant assets
• Loss on impairment of assets
• Loss on investment in common stock using equity method
2) Deductions:
• Amortization of bonds premium
• Increase in receivables
• Increase in inventories
• Increase in prepaid expenses
• Decrease in payables
• Decrease in accrued expenses
• Decrease in income tax liability
• Gain on sales of plant assets
• Gain on investment in common stock using equity method
(2) Direct method: Adjust each item in the income statement from the accrual basis to the cash basis.
Cash in:
1) Cash receipt from customer: adjust the change of AR to sales revenue. If decrease, add the difference to sales revenue; if increase, deduct it from sales revenue.
2) Cash receipt of interest and dividends on loans and investments, if any.
Cash out:
1) Cash payment to suppliers: First determine purchases. Inventory increasing during the year means purchases exceed COGS. Company adds the increase in inventory to COGS to arrive at total purchases. Then, determine cash payments to suppliers by adjusting the change in AP to purchase. if increase, deduct the difference in AP from purchase to arrive at cash payments to suppliers. Conversely, adds the decrease in AP to purchase.
2) Cash payments for operating expenses: Prepaid expense and accrued expense.
Prepaid expense: If increase, add the increase to operating expenses. If decrease, deduct from operating expenses the amount of the decrease.
Accrued expense: If increase, deduct the increase from the operating expenses. If decrease, add the decrease back to the operating expenses.
3) Cash payments for income taxes
4) Cash payment for interest
5) Cash payment to employees
(1) Indirect method: Add back or deduct from net income those items that had no effect on cash.
1) Additions:
• Depreciation of tangible fixed assets
• Amortization of intangibles
• Amortization of deferred charges
• Amortization of bond discount
• Decrease in receivables
• Decrease in inventories
• Decrease in prepaid expenses
• Increase in payables
• Increase in accrued expenses
• Increase in deferred income tax liabilities
• Loss on sales of plant assets
• Loss on impairment of assets
• Loss on investment in common stock using equity method
2) Deductions:
• Amortization of bonds premium
• Increase in receivables
• Increase in inventories
• Increase in prepaid expenses
• Decrease in payables
• Decrease in accrued expenses
• Decrease in income tax liability
• Gain on sales of plant assets
• Gain on investment in common stock using equity method
(2) Direct method: Adjust each item in the income statement from the accrual basis to the cash basis.
Cash in:
1) Cash receipt from customer: adjust the change of AR to sales revenue. If decrease, add the difference to sales revenue; if increase, deduct it from sales revenue.
2) Cash receipt of interest and dividends on loans and investments, if any.
Cash out:
1) Cash payment to suppliers: First determine purchases. Inventory increasing during the year means purchases exceed COGS. Company adds the increase in inventory to COGS to arrive at total purchases. Then, determine cash payments to suppliers by adjusting the change in AP to purchase. if increase, deduct the difference in AP from purchase to arrive at cash payments to suppliers. Conversely, adds the decrease in AP to purchase.
2) Cash payments for operating expenses: Prepaid expense and accrued expense.
Prepaid expense: If increase, add the increase to operating expenses. If decrease, deduct from operating expenses the amount of the decrease.
Accrued expense: If increase, deduct the increase from the operating expenses. If decrease, add the decrease back to the operating expenses.
3) Cash payments for income taxes
4) Cash payment for interest
5) Cash payment to employees
