Direct & Indirect Method (19,2)

Question 1

Things to know about indirect vs. direct method

Answer 1

CFO is calculated differently, but the result is the same under both methods.
The calculation of CFI and CFF is identical under both methods.
There is an inverse relationship between changes in assets and changes in cash flows. In other words, an increase in an asset account is a use of cash, and a decrease in an asset account is a source of cash.
There is a direct relationship between changes in liabilities and changes in cash flow. In other words, an increase in a liability account is a source of cash, and a decrease in a liability is a use of cash.
Sources of cash are positive numbers (cash inflows) and uses of cash are negative numbers (cash outflows).

Question 2

The steps in calculating CFO under the indirect method

Answer 2

The steps in calculating CFO under the indirect method can be summarized as follows:

Step 1: Begin with net income.

Step 2: Add or subtract changes to balance sheet operating accounts as follows:

Increases in the operating asset accounts (uses of cash) are subtracted, while decreases (sources of cash) are added.
Increases in the operating liability accounts (sources of cash) are added, while decreases (uses of cash) are subtracted.

Step 3: Add back all noncash charges to income (such as depreciation and amortization) and subtract all noncash components of revenue.

Step 4: Subtract gains or add losses that resulted from financing or investing cash flows (such as gains from sale of land).