Understanding the Indirect Method for Preparing a Statement of Cash Flows

When it comes to understanding the financial health of a company, one important tool is the statement of cash flows. This document provides a snapshot of a company's inflows and outflows of cash over a specific period, helping stakeholders understand how the business is performing financially. In this article, we'll delve into the indirect method for preparing a statement of cash flows, specifically focusing on Step 1: Determine Net Cash Flows from Operating Activities.

The Importance of Adjusting for Changes in Current Assets and Liabilities

Before diving into the preparation process, it's essential to understand that the statement of cash flows is not simply an extension of the income statement. The indirect method requires adjustments to net income to reflect changes in current assets and liabilities that may not have affected cash flow. This is particularly important for items such as accounts receivable and payable, inventory, and prepaid expenses.

Calculating Operating Net Cash Flow

To calculate operating net cash flow using the indirect method, we begin with net income from the income statement. We then make several adjustments to remove non-cash items and reflect changes in current assets and liabilities that affect cash flow.

* Adjust for changes in current assets and liabilities: This step helps to remove accruals from operating activities, which may not have affected cash flow.

* Reverse the effect of gains and/or losses from investing activities: Gains and losses from the disposal of long-term assets are reported under investing cash flows, so we need to remove their effects on net income.

In conclusion, preparing a statement of cash flows using the indirect method requires careful consideration of changes in current assets and liabilities. By following the steps outlined above, including Step 1: Determine Net Cash Flows from Operating Activities, stakeholders can gain valuable insights into a company's financial performance and make informed decisions.

Cashflow book