{"id":664,"date":"2018-04-19T20:43:38","date_gmt":"2018-04-19T20:43:38","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/?post_type=chapter&#038;p=664"},"modified":"2024-04-29T17:36:17","modified_gmt":"2024-04-29T17:36:17","slug":"the-indirect-method","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/chapter\/the-indirect-method\/","title":{"raw":"The Indirect Method","rendered":"The Indirect Method"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li>Calculate cash flows from operating activities by the indirect method<\/li>\r\n<\/ul>\r\n<\/div>\r\nLet\u2019s look at the indirect method first.\u00a0The indirect method starts with your net income and adds or subtracts the items based on changes in their balances.\r\n\r\nRemember the operating activities that affect cash flow:\r\n<table border=\"1\">\r\n<tbody>\r\n<tr>\r\n<td><strong>Description<\/strong><\/td>\r\n<td><strong>Inflow<\/strong><\/td>\r\n<td><strong>Outflow<\/strong><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Collect cash from your customers<\/td>\r\n<td style=\"text-align: center;\">X<\/td>\r\n<td style=\"text-align: center;\"><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Pay for inventory<\/td>\r\n<td><\/td>\r\n<td style=\"text-align: center;\">X<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Pay your bills! (utilities, rent, insurance)<\/td>\r\n<td><\/td>\r\n<td style=\"text-align: center;\">X<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Pay your employees<\/td>\r\n<td><\/td>\r\n<td style=\"text-align: center;\">X<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Pay interest on loans<\/td>\r\n<td><\/td>\r\n<td style=\"text-align: center;\">X<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Pay your taxes<\/td>\r\n<td><\/td>\r\n<td style=\"text-align: center;\">X<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nThere are related accounts on the balance sheet, so that when changes happen, we need to know how they affect the statement of cash flows:\r\n<table style=\"border-collapse: collapse; width: 70%;\" border=\"1\">\r\n<thead>\r\n<tr style=\"height: 15px;\">\r\n<td style=\"width: 25%; height: 15px;\"><\/td>\r\n<th style=\"width: 5%; height: 15px; text-align: center;\" scope=\"col\">If the account balance increases<\/th>\r\n<th style=\"width: 5%; height: 15px; text-align: center;\" scope=\"col\">If the account balance decreases<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 25%; height: 15px;\" scope=\"colgroup\"><strong>Current Assets<\/strong><\/th>\r\n<td style=\"width: 5%; height: 15px;\"><\/td>\r\n<td style=\"width: 5%; height: 15px;\"><\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Accounts Receivable (money from customers)<\/th>\r\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\r\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Inventory (buy or pay for inventory)<\/th>\r\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\r\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Prepaid expenses (insurance)<\/th>\r\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\r\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<td style=\"width: 25%; height: 15px;\"><\/td>\r\n<td style=\"width: 5%; height: 15px;\"><\/td>\r\n<td style=\"width: 5%; height: 15px;\"><\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 25%; height: 15px;\" scope=\"colgroup\"><strong>Current Liabilities<\/strong><\/th>\r\n<td style=\"width: 5%; height: 15px;\"><\/td>\r\n<td style=\"width: 5%; height: 15px;\"><\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Accounts Payable (pay your bills)<\/th>\r\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\r\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Accrued Liabilities (payroll)<\/th>\r\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\r\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Income taxes payable (tax payments)<\/th>\r\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\r\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nThis can be a confusing concept, so let\u2019s look at some examples.\r\n<ul>\r\n \t<li>1\/1\/20XX Accounts Receivable Balance \u00a0\u00a0\u00a0$5000<\/li>\r\n \t<li>1\/31\/20XX Accounts Receivable Balance \u00a0$4000<\/li>\r\n<\/ul>\r\nThe account balance <strong>decreased<\/strong>, so we need to <strong>add<\/strong> $1000 to our cash for the month <strong>because<\/strong> we received that much more in cash from our customers.\r\n\r\nLet\u2019s look at another example:\r\n<ul>\r\n \t<li>1\/1\/20XX Accounts Payable Balance \u00a0\u00a0\u00a0$8000<\/li>\r\n \t<li>1\/31\/20XX Accounts Payable Balance \u00a0$5000<\/li>\r\n<\/ul>\r\nThe account balance <strong>decreased<\/strong>\u00a0so we need to <strong>subtract<\/strong>\u00a0$3000 from our cash for the month <strong>because<\/strong> we paid down our accounts payable balance.\r\n\r\nIf you are working on a cash flow statement, you can keep the little chart with you. Complete the practice question to check your understanding.\r\n<div class=\"textbox tryit\">\r\n<h3>Practice Questions<\/h3>\r\nhttps:\/\/assess.lumenlearning.com\/practice\/08ca1078-7afa-4543-abc9-165977faf55f\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li>Calculate cash flows from operating activities by the indirect method<\/li>\n<\/ul>\n<\/div>\n<p>Let\u2019s look at the indirect method first.\u00a0The indirect method starts with your net income and adds or subtracts the items based on changes in their balances.<\/p>\n<p>Remember the operating activities that affect cash flow:<\/p>\n<table>\n<tbody>\n<tr>\n<td><strong>Description<\/strong><\/td>\n<td><strong>Inflow<\/strong><\/td>\n<td><strong>Outflow<\/strong><\/td>\n<\/tr>\n<tr>\n<td>Collect cash from your customers<\/td>\n<td style=\"text-align: center;\">X<\/td>\n<td style=\"text-align: center;\"><\/td>\n<\/tr>\n<tr>\n<td>Pay for inventory<\/td>\n<td><\/td>\n<td style=\"text-align: center;\">X<\/td>\n<\/tr>\n<tr>\n<td>Pay your bills! (utilities, rent, insurance)<\/td>\n<td><\/td>\n<td style=\"text-align: center;\">X<\/td>\n<\/tr>\n<tr>\n<td>Pay your employees<\/td>\n<td><\/td>\n<td style=\"text-align: center;\">X<\/td>\n<\/tr>\n<tr>\n<td>Pay interest on loans<\/td>\n<td><\/td>\n<td style=\"text-align: center;\">X<\/td>\n<\/tr>\n<tr>\n<td>Pay your taxes<\/td>\n<td><\/td>\n<td style=\"text-align: center;\">X<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>There are related accounts on the balance sheet, so that when changes happen, we need to know how they affect the statement of cash flows:<\/p>\n<table style=\"border-collapse: collapse; width: 70%;\">\n<thead>\n<tr style=\"height: 15px;\">\n<td style=\"width: 25%; height: 15px;\"><\/td>\n<th style=\"width: 5%; height: 15px; text-align: center;\" scope=\"col\">If the account balance increases<\/th>\n<th style=\"width: 5%; height: 15px; text-align: center;\" scope=\"col\">If the account balance decreases<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr style=\"height: 15px;\">\n<th style=\"width: 25%; height: 15px;\" scope=\"colgroup\"><strong>Current Assets<\/strong><\/th>\n<td style=\"width: 5%; height: 15px;\"><\/td>\n<td style=\"width: 5%; height: 15px;\"><\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Accounts Receivable (money from customers)<\/th>\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Inventory (buy or pay for inventory)<\/th>\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Prepaid expenses (insurance)<\/th>\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<td style=\"width: 25%; height: 15px;\"><\/td>\n<td style=\"width: 5%; height: 15px;\"><\/td>\n<td style=\"width: 5%; height: 15px;\"><\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 25%; height: 15px;\" scope=\"colgroup\"><strong>Current Liabilities<\/strong><\/th>\n<td style=\"width: 5%; height: 15px;\"><\/td>\n<td style=\"width: 5%; height: 15px;\"><\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Accounts Payable (pay your bills)<\/th>\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Accrued Liabilities (payroll)<\/th>\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 25%; height: 15px;\" scope=\"row\">Income taxes payable (tax payments)<\/th>\n<td style=\"width: 5%; height: 15px;\">Add<\/td>\n<td style=\"width: 5%; height: 15px;\">Subtract<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>This can be a confusing concept, so let\u2019s look at some examples.<\/p>\n<ul>\n<li>1\/1\/20XX Accounts Receivable Balance \u00a0\u00a0\u00a0$5000<\/li>\n<li>1\/31\/20XX Accounts Receivable Balance \u00a0$4000<\/li>\n<\/ul>\n<p>The account balance <strong>decreased<\/strong>, so we need to <strong>add<\/strong> $1000 to our cash for the month <strong>because<\/strong> we received that much more in cash from our customers.<\/p>\n<p>Let\u2019s look at another example:<\/p>\n<ul>\n<li>1\/1\/20XX Accounts Payable Balance \u00a0\u00a0\u00a0$8000<\/li>\n<li>1\/31\/20XX Accounts Payable Balance \u00a0$5000<\/li>\n<\/ul>\n<p>The account balance <strong>decreased<\/strong>\u00a0so we need to <strong>subtract<\/strong>\u00a0$3000 from our cash for the month <strong>because<\/strong> we paid down our accounts payable balance.<\/p>\n<p>If you are working on a cash flow statement, you can keep the little chart with you. Complete the practice question to check your understanding.<\/p>\n<div class=\"textbox tryit\">\n<h3>Practice Questions<\/h3>\n<p>\t<iframe id=\"assessment_practice_08ca1078-7afa-4543-abc9-165977faf55f\" class=\"resizable\" src=\"https:\/\/assess.lumenlearning.com\/practice\/08ca1078-7afa-4543-abc9-165977faf55f?iframe_resize_id=assessment_practice_id_08ca1078-7afa-4543-abc9-165977faf55f\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:300px;\"><br \/>\n\t<\/iframe>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-664\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>The Indirect Method. <strong>Authored by<\/strong>: Freedom Learning Group. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":62559,"menu_order":8,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"The Indirect Method\",\"author\":\"Freedom Learning Group\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"5de8c574-5601-4d83-a65b-2cd3e0a85142, dd38f4ef-0d3c-43ad-a4c0-581fff915eed","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-664","chapter","type-chapter","status-publish","hentry"],"part":112,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/664","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/users\/62559"}],"version-history":[{"count":12,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/664\/revisions"}],"predecessor-version":[{"id":4164,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/664\/revisions\/4164"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/parts\/112"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/664\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/media?parent=664"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapter-type?post=664"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/contributor?post=664"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/license?post=664"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}