Cash Flow Statement Indirect Method Preparation, Format & Example

Definition

indirect method cash flow statement, whereby profit or loss is adjusted for the effects of transactions of a non-cash items, any deferrals or accruals of past or future operating cash receipts or payments and items of income or expense associated with investing of financing cash flows. (IAS 7 Para 18)

Mostly companies prepare cash flow statements under indirect method because this method provides comprehensive financial information and details under operating activities as opposed to direct method of cash flow statement. Under indirect method cash flow statement net profit is presented before taxation’s effects and this net profit is adjusted for certain items in order to work out cash generated from operations.  These adjustments are:

Non-cash Items

All the non-cash items already charged against net profit are added back to the net profit because these expenses do not represent any cash outflow in actual. The figure of net profit shown in the cash flow statement should represent the’ cash figure’ and for this purpose these non-cash items of expenses are added back. These items may include depreciation, amortization etc.

Working Capital Changes

The items of working capital encompass account receivables, prepayments, closing stock of inventories, account payables and accruals. Cash generated from operations is adjusted with the changes in working capital. Keep in mind that while working out the ‘working capital’, accruals relating to interest, income tax and dividends are not taken into account. More precisely, these items are excluded from ‘working capital’.

The reason why accrued interest, income tax and dividends are omitted from working capital changes is that these items are separately shown in the statement of cash flow under specific headings of interest paid, tax paid and dividend paid. These items charged on accrual basis are at first added back to net profit and then presented as cash outflow on cash basis.

The computation for interest, income tax and dividends paid is shown later on in this topic, which is similar in both direct and indirect method cash flow statement.

Items of investing and financing activities

There are certain items which according to the principles of cash flow statement are not to be shown under operating activities but the same should be disclosed under investing or financing activities. The effects of such items are adjusted accordingly against the figure of net profit displayed under operating activities.

Computation of Interest, Income Tax and Dividends Paid

Computer of Interest Paid 

Computation Income Tax Paid 

Computation of Dividends Paid

Example and Preparation

The following are the balance sheets of A Traders as at December 31, 2015 and December 31, 2014 and extracts of Profit and Loss Account for the year ended December 31, 2015. You are required to prepare indirect method cash flow statement. This example shows students the calculations and format of cash flows.

Profit and Loss Account

Net sales  95,000

Cost of goods sold  (44,000)

Gross profit  51,000

Operating expenses (including deprecation)  (28,600)

Net profit   22,400

Dividend declared and paid  20,000

Additional information

During the year furniture costing 10,000 dollars on which 8,000 dollars deprecation was provided, sold for $ 1,500. The loss on disposal is included in selling and administrative expenses.