## Direct and Indirect Methods Compared

### Learning Outcomes

• Distinguish between the direct and indirect methods of preparing a statement of cash flows

Cash flows from operating activities show the net amount of cash received or disbursed during a given period for items that normally appear on the income statement. You can calculate these cash flows using either the direct or indirect method. The direct method deducts from cash sales only those operating expenses that consumed cash. This method converts each item on the income statement directly to a cash basis. Alternatively, the indirect method starts with accrual basis net income and indirectly adjusts net income for items that affected reported net income but did not involve cash.

The direct method converts each item on the income statement to a cash basis. For instance, assume sales are stated at $45,785 on an accrual basis. If accounts receivable decreased by$15, from $1,750 to$1,735, cash collections from customers would have been $45,800, which you could calculate in a T account or in a table as follows: Beginning balance$     1,750 45,785 47,535 1,735 $45,800 Here is a hypothetical example of a statement of cash flows prepared using the direct method: Rumble Corp. Statement of Cash Flows for the year ended 12/31/x1 Description Amount Total In millions Subcategory, Cash flows from operating activities Cash receipts from customers$ 45,800
Cash paid to suppliers (29,800)
Cash paid to employees (11,200)
Cash generated from operations Single Line
4,800
Interest paid (310)
Income taxes paid (1,700)
Net cash from operating activities Single Line Single Line
$2,790 Subcategory, Cash flows from investing activities Purchase of property, plant, and equipment (580) Proceeds from sale of equipment 150 Net cash used in investing activities Single Line Single Line (430) Subcategory, Cash flows from financing activities Proceeds from issuance of common stock 1,000 Proceeds from issuance of long-term debt 500 Dividends paid (460) Net cash used in financing activities Single Line Single Line 1,040 Net increase in cash and cash equivalents 3,400 Cash and cash equivalents at beginning of period 1,640 Cash and cash equivalents at end of period Single Line$5,040
Double Line

The indirect method adjusts net income (rather than adjusting individual items in the income statement) for (1) changes in current assets (other than cash) and current liabilities, and (2) items that were included in net income but did not affect cash. We’ll explore this in more detail in a later section.