Indirect Method

Posted in Finance, Accounting and Economics Terms, Total Reads: 482
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Definition: Indirect Method

A method for preparing a statement of cash flows which is one of the major components of a company’s periodic financial statements.


Cash flows are used to provide information about the cash flows associated with the period’s operations, investing and financing activities. The sources and uses are cash are revealed in the cash flow statement.


The cash flow from operating activities can be prepared by 2 methods, direct and indirect. In the direct method of reporting cash flows from operating activities, amounts of operating inflows and outflows are presented and then pooled to attain the net cash flow from operations. But as the direct method does not present the reason why the net income (PAT) varies from the net operating cash flows, it is not favored by most companies.


In the indirect method, the approach is to begin with net income and add adjustments for differences between revenues and operating cash inflows as well as expenses and operating cash outflows. The critical adjustment in operating activities cash flow is generally the depreciation.


The cash flow from investing and financing activities are same in both methods. The indirect method presents better relation between cash flows from operating, investing and financing activities.

 

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