Operating Activities of Cash Flow Statement Under Indirect Method

Cash flow from operating activities under indirect method: Cash flows from operations are generated from the organization’s normal activities. These cash flows are generally routine and recurring. They are particularly important because most organizations must be capable of generating positive cash flows from operations over the long run to remain viable. It deals with the cash generated or used by the entity’s primary activities. The cash flow statement reports past cash flows, but the same or similar activities and cash flows can be expected to occur in the future. In this section under indirect method company start with accrual-basis net income and adjust that figure to obtain the cash generated or used by operations. Although accrual-basis income is regarded as the best measure of operating success, it does not tell us the amount of cash flows from operating and must be adjusted for all items that affect income and cash differently.

Thus, this section of the cash flow statement includes the following adjustments to net income to determine the cash generated or used by operations:

1. Expenses that reduced net income this period but did not use cash must be added back.

2. Cash payments made this period for expenses of other periods must be deducted.

3. Revenues that did not result in cash inflows during the current period must be deducted.

4. Cash collections for revenues earned in other periods must be added.

5. Items reported in the income statement but not directly related to normal operations

must be removed

Let’s consider a few of the more common adjustments or noncash effect to net income that are needed to convert to a cash basis.

Depreciation:

Under accrual accounting, income is reduced for the cost of an operating asset’s service potential

used up during the period. As we have seen earlier, depreciation, or the amount of cost recognized during the period under the matching concept, is an allocation of the original cost of the...