How to Prepare a Statement of Cash Flows Using the Indirect Method

How to Prepare a Statement of Cash Flows Using the Indirect Method

Statement of Cash Flows is just one of three reports that every company is required to produce at the conclusion of every accounting period. The other two financial statements include the balance sheet and the income statement. The financial statements are utilized as internal documents that direct the company’s activities. They also serve as reports for clients, investors, and Board of Directors members and for government agencies.

The cash flow statement is composed of three parts that include cash from operations as well as cash from investing activities and cash in financing transactions.

What is the Indirect Method for Preparing a Statement of Cash Flows?

The indirect method of creating the statement of the flow of money is a method that starts with the net income from the income statement that is then adjusted to reflect other non-cash expenses like depreciation. It is founded upon the accrual method of accounting and is usually the most effective method as most companies use accrual accounting for their bookkeeping.

The most direct method of preparing an account of cash flows includes cash outflows and cash inflows at the time they occur. It is built on the concept of cash accounting. This is because the Financial Accounting Standards Board (FASB) prefers that firms utilize the direct method for preparing the cash flow statement. Since the majority of firms utilize the accrual method, they usually employ the indirect method.

The Relationship Between the Balance Sheet and Statement of Cash Flows

The cash account in the balance sheet should reflect the amount of cash in the company according to the cash flow statement. 1 The following five factors could cause an imbalance between the balance sheet’s cash balance and the cash flow statement flows, and therefore adjustments need to be taken. These elements should be reported in the cash flow statement: flows:

  1. Net income prior to preferred dividends Net income, derived from the income statement usually signifies higher cash reserves in the banks. If a company is able to issue preferred stocks then net income may be lower because of the need to pay dividends.
  2. Adjustments for non-cash net income To estimate cash flow you must add the non-cash costs like amortization and depreciation.
  3. Working capital changes working capital: Working capital refers to the assets that are currently owned by the company. The increase of current assets (other than cash) reduces cash, and the decrease in current assets increases the amount of cash. Also, an increase in current liabilities adds to the cash account, while the reduction in current liabilities will reduce cash. This is reflected in the cash flow statement. flows.
  4. Investments When a company puts its money into fixed assets, or in short-term financial investments and the cash balance is reduced. If it sells fixed assets or short-term financial investments, the amount is increasing. This should be recorded in the cash statement flows.
  5. Dividends and transactions in securities If a company issues bonds or common stock and dividends, it should be reported in the cash flow statement circulation as an addition to the balance. If instead, it purchases back its stock or settles debt which is a reduction of the account balance. If the business distributes dividends to stockholders of common stock then the cash account is reduced.

The best format for an accounting of cash flows statement is to break the cash flow changes into three parts: 2

Cash Flows From Operations

The first part of the cash flow is devoted to the company’s working capital. The changes in working capital are subtracted from or added to the net income of the firm according to Item 2 above.

Depreciation is a planned decrease in the price of fixed assets as it is utilized. In order to calculate cash flow from operations, take all of the depreciation costs of your assets in order to calculate total depreciation costs. Look at the formula below:

Cash Flows from investing activities

This section summarizes the modifications of the Fixed Asset Account, or your current liability account except for accounts payable. This covers the purchase or sale of fixed assets like equipment or plant and also issuing or buying shares of the common stock. The guidelines for recording the changes are found in Item 3 above.

Other activities include settlement collection as well as loaning money and paying back loans you’ve taken out. This section focuses on investment activities such as buying shares of stock, but not financing like securing funds.

Cash Flow from Financing Activity

The section in the financial statement flows reveals the company’s financial activities, which are not included in the investing section — that resulted from the transactions that resulted in funding or the returning the funds as well as the dividends paid. The changes that appear in the section on cash flow result from the actions that the company uses to fund its operations.

The selling of company stock as financing could be noted in this section together with the repurchase of shares, dividend payments, and debt repayments (as they are in connection with a financing process). Short-term and long-term changes in debt are also recorded in this section. Any payments that are made are negative ones, as are any received payments, which are positive changes.

Cash Flow Statement Example

After you’ve calculated the elements you need to consider once you have calculated the necessary elements, you can start creating your own cash flow statement. For smaller firms, it is possible that you don’t be involved in one of the investment strategies mentioned previously. In this situation, you do not have to provide any information.

The total increase or decrease in the cash account of the company is the amount of these three segments.

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