How to Prepare a Statement of Cash Flows Using the Indirect Method

Preparing a Statement of Cash Flows Using the Indirect Method

Business people a cash flow statement

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The statement of cash flows provides valuable information about a company's gross payments and receipts and allows insights into its future income needs. The cash flows statement is comprised of three sections: operating activities, investing activities, and financing activities. 

The indirect method of preparing a statement of cash flows begins with the net profit from the income statement, which is then adjusted for non-cash items, such as depreciation.

Cash Flows From Operations

Elements you need to complete on section one are earnings before interest and taxes (EBIT) and depreciation. Depreciation is a planned reduction in the value of a fixed asset as it is used. For the purpose of cash flows from operations, add all of your assets' depreciation expenses together to arrive at total depreciation expenses.

EBIT is a representation of the ability of your firm to earn from operations. This means that the value represented by EBIT does not have any finance costs (interest) or governmental influences (taxes).

EBIT is derived from your net profits in the following equation:

Net Profit - Interest Expenses - Income Tax = EBIT

Calculate the cash from operating activities as follows:

EBIT + Depreciation = Cash from Operating Activities

Cash Flow from Investing Activities

This section is a summation of the investment gains or losses a company encountered in a period. It includes purchasing or selling fixed assets, such as a plant or equipment.

Other activities include purchasing of investments, settlement collections, loaning money, or collecting on loans you have made. This section deals with investing activities, like purchasing shares of stock, not financing activities such as securing funding.

When you purchase assets, investments, or create new loans, you document a negative flow of cash. If you sell them or collect on a debt, you record a positive cash flow—you brought cash in.

Cash Flow from Financing Activities

This is a section that shows the financial activities not recorded in investing activities that were a result of transactions for long-term funding or return of the funds. Activities in this section are a direct result of receiving and making payments on loans.

The sale of company stock for financing can be recorded in this section, along with repurchase of stock, dividend payment, debt repayments (as long as it is for a financing activity). Any payment going out are negative cash flows, and any payments received are positive cash flows.

Cash Flow Statement Example

Once you have calculated the necessary elements, you can begin to build your statement of cash flows. For smaller businesses, you may not have any of the investment activities discussed previously. In this case, you would not need to enter any information.

Values in parentheses are negative, representing withdrawals, or debits. Enter the values you have in the appropriate section, and then sum the values for each section.

Net Increase in Cash and Cash Equivalents is the sum of the three sections. Add this to the Cash at the Beginning of the Period. The result is Cash at the End of the Period, and completes your statement of cash flows.

Cash Flows From Operations

Net income $300,000

Depreciation ($10,000)

Accounts Payable ($20,000)

Accounts Receiveable $10,000

Net Change ($20,000)

Net Cash From Operations $280,000

Cash Flows From Investing Activities

Sale of Property $35,000

Equipment Purchase $(15,000)

Net Cash From Investment Activities $20,000

Cash Flows From Financing Activities

Loan Payment ($10,000)

Loan Collection $5,000

Net Cash From Financing Activities ($5000)

Net Increase in Cash and Cash Equivalents $280,000

Cash and Cash at Beginning of Period $256,000

Cash and Cash at End of Period $536,000