Cash Flow Statement Method

In order to prepare a cash flow statement by indirect method we have to divide the cash flow activities into three different categories. These categories are:-

Financing Activities of Cash Flow

Financing activities of the cash flow are the activities in which a firm enjoys cash in flows from its investors such as creditors and banks. The cash outflow as paying the dividend to the share holders is also considered to be the financing activity of a firm. Long term liabilities and equities are also listed in the financing activities of a firm. Other financing activities include repurchase of the company shares, repayment of the debt principle, receipts of donor donated cash in the case of non-profit organizations and NGOs.

Investing Activities of Cash Flow

Investing activities involve the sales and purchase of the assets. The sale of the asset is termed as cash in flow where the purchase of the assets is termed as cash outflow. Assets involve land, property, equipments, offices, buildings and marketable securities of a firm. Other investing activities include loan received by the customers and loans issued to the suppliers. Moreover payments related to the mergers and acquisitions are also included in investing activities.

Operating Activities

All the activities related to the production, sales and marketing of the goods and services are included in the operative activities. In include purchasing raw material for production, cost spent on building and maintaining inventory, cost involved in marketing, advertising and shipping the product to the end user. Operating cash flows include receipts of the goods or services sold to the customers, receipts of loans, debt and equity portfolio of the firm, interest that is earned on the issued loans, payment that is done to the suppliers on receiving the goods or raw material, salaries of the employees, payments made as interest and cost of the purchased merchandise. All these activities are required to prepare an accurate and precise cash flow statement by indirect method.

Although preparing cash flow statement with the help of indirect method is a complex approach as compared to preparing it with direct method but almost 95 percent of firms prefer indirect method to prepare cash flow statements as compared to the direct method.  The reason behind using the indirect method to prepare cash flow statement is that it shows a relationship between the other two financial statements and these are the balance sheet and the income statement. Another advantage of indirect method over direct method is that it avoids duplication of effort of reconciling net income with cash flows from the operating activities. The name also indicates that it operates indirectly from the net income instead of starting from actual disbursement of cash and cash receipts. 

The major advantage of preparing income statement with indirect method is that it helps in calculating the liquidity and solvency of the firm and helps in measuring the ability of the firm to change or transform its cash flows. The indirect method of cash flow statement also helps us in analyzing other statements such as balance sheet and income statement and hence it helps in examining the change in assets, liabilities and equities of a firm. The indirect cash flow statements of two different companies help in comparing the operating performance of the companies. With the help of indirect cash flow statement we can measure the timings of the future cash flows. In addition to that it also helps in measuring the probability and the amount of future cash flows. Another benefit of cash flow indirect statement is that it is less costly to convert net income to net cash by operating activities. The method also highlights the difference that actually exits between the reported profit and net cash flow using operating activities.