Indirect Cash Flow Method

Indirect Cash Flow Method

A technique for preparing the operating section of the cash flow statement by adjusting net income for non-cash items, deferrals, accruals, and changes in working capital accounts to reconcile accrual-based earnings with actual cash flows.

For example, a company reporting $500,000 in net income would adjust for non-cash depreciation ($150,000), increases in accounts receivable (-$80,000), decreases in inventory ($60,000), and increases in accounts payable ($45,000) to determine operating cash flow of $675,000, explaining the difference between earnings and cash generation.

This widely used approach reconciles accrual accounting profit with cash flow by adding back non-cash expenses (like depreciation and amortization), adjusting for non-operating items (like gains or losses on asset sales), and accounting for working capital changes. Increases in current assets (like receivables or inventory) represent cash uses requiring subtraction, while increases in current liabilities (like payables or accrued expenses) represent cash sources requiring addition. Though presenting less detailed transaction information than the direct method, the indirect approach efficiently connects income statement and balance sheet data while highlighting key drivers of the gap between reported earnings and operating cash flow.