23.2: The Direct and Indirect Methods

Question 1

What is the relationship between changes in assets and changes in cash flows?

Answer 1

There is an inverse relationship between changes in assets and changes in cash flow.

Increase in asset = outflow
Decrease in asset = inflow

Question 2

What is the relationship between changes in liabilities and changes in cash flows?

Answer 2

There is a direct relationship between changes in liabilities and changes in cash flow.

Increase in liabilities = inflow
Decrease in liabilities = outflow

Question 3

What equation is used to calculate CFI?

Answer 3

cash paid for new asset = ending gross assets + gross cost of old assets sold - beginning gross assets

Question 4

What equations are used to calculate CFF?

Answer 4

net cash flows from creditors = new borrowings - principal amounts repaid

net cash flows from shareholders = new equity issued - share repurchases - cash dividends paid

Question 5

What are the steps to calculate CFO under the indirect method?

Answer 5

1. Begin with net income
2. Add or subtract changes to B/S operating accounts
3. Add back all noncash charges to income (depreciation, amortization) and subtract all noncash components of revenue
4. Subtract gains or add losses that resulted from financing or investing cash flows