Two generally accepted formats can be used
to report operating activities
, the direct method
and the indirect method
, the cash effect of each operating activity is reported directly in the statement. EX, cash received from customers is reported as the cash effect of sales activities. Income statement transactions that have no cash flow effect, such as depreciation, are simply not reported
.By the direct method , the cash effect of each operating activity is reported directly in the SCF.
, on the other hand, we arrive at net cash flow from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a cash basis
. Two types of adjustments to net income are needed. First, components of net income that do not affect cash are reversed. That means that noncash revenues and gains are subtracted, while noncash expenses and losses are added. For example, depreciation expense does not reduce cash, but it is subtracted in the income statement. To reverse this, then, we add back depreciation expense to net income to arrive at the amount that we would have had if depreciation had not been subtracted
- By the indirect method ,
- cash flow from operating activities is derived indirectly by starting with reported net income and adding or subtracting items to convert that amount to a cash basis.
- Second, we make adjustments for changes in operating assets and liabilities during the period that indicate that amounts included as components of net income are not the same as cash flows for those components.
- For instance, suppose accounts receivable increases during the period because cash collected from customers is less than sales revenue. This increase in accounts receivable would then be subtracted from net income to arrive at cash flow from operating activities.
- In the indirect method, positive adjustments to net income are made for decreases in related assets and increases in related liabilities, while negative adjustments are made for increases in those assets and decreases in those liabilities.