Let’s assume that a company’s net income is $120,000, the depreciation of its assets is $50,000, and it pays dividends worth $85,000. Here is its cash flow statement, prepared by analyzing the account values from the balance sheet. For this example, we’ll use the following comparative balance sheet for the past two years. The increase or decrease of cash in each asset and liability account is recorded in the cash flow statement. In order to calculate cash flow, you must have two years of balance sheets and income statements for reference. When you calculate cash flow using the indirect method, you need to adjust the net income by converting it from the accrual basis to the cash basis. Then, add the non-cash expenses including depreciation, amortization, unrealized gains and losses, and stock-based compensation. Many companies prefer this method over the direct method because all factors are taken into account. It is a time-consuming, complex process yet many companies adopt this for the sake of accuracy. This can be achieved using indirect method where adjustments are made to convert accrual transactions to cash before calculating cash flow. Since these two documents act as inputs for generating cash flow statement, the accrual values have to be converted to cash for calculating cash flow. Here the values noted inside parentheses are negative, indicating outgoing cash.Ĭash flow statement shows transactions only in cash format but most companies generate the balance sheet and the income statement using accrual transactions. Let’s look at an example of calculating cash flow using the direct method. Once you add the cash value for investing and financing activities, you can see the net cash increase or decrease. Under the direct cash flow method, the values of the accounts in your operations section are recorded on the cash basis. After listing the cash receipts and payments, subtract the outgoing cash from the incoming cash to arrive at the net cash flow for operating activities. This can help you determine the net decrease or increase in cash in these accounts. You arrive at these numbers by calculating the difference between the beginning and ending balances of each account in the balance sheet. You add all the cash payments and receipts, including the amount paid to suppliers, receipts from customers, and cash distributed as salaries. In the direct method, you use the cash flow information from the operations segment of the company’s cash flow statement. There are two ways you can evaluate a company’s cash flow: the direct method and the indirect method. The differences used to make the adjustments are taken from two or more balance sheets and income statements. Non-cash items also count while calculating net income in an income statement or assets and liabilities in a balance sheet. Cash flow for non-cash items is calculated by adjusting the company’s net income based on differences in revenue, expenses, and credit over a time period. Not all financial transactions involve cash.

Indirect method cash flow example