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Statement of Cash Flows

Tips & Tricks for Direct Method

Rule: No non-cash items are included when preparing a Statement of Cash Flows using the direct method
(i.e., Depreciation, Gains, Losses, etc.).

Step 1: Calculate the difference between the beginning and ending balances for all Balance Sheet accounts, jotting down to one side.

Step 2: Begin with the Income Statement.

          a)  Revenues:  Calculate the amount of revenues actually collected during the current period. Assume that all revenues pass through the Accounts Receivable account. Likewise, any other income will pass through an associated Receivable account (i.e., Interest Receivable).

Formula: (Use this one when all given information is in Debit (DR) column)

Beginning Balance
+  Revenue or Income
<Ending Balance>
Cash Receipts

          b)  Check off Revenue (and/or Income) and Accounts Receivable (or other Receivable) on Balance Sheet as completed. (NOTE: Repeat this check-off step for each transaction to follow).

          c)  Cost of Goods Sold:  Calculate the amount of Inventory started and completed during the current period.

Formula: (Use this one when given information is in both the Debit (DR) and Credit (CR) columns of the Ledger or T-account)

Ending Balance
<Beginning Balance>
+  Expense
Cash Payments

To this amount, add any decrease in Accounts Payable (A/P), or deduct any increase in A/P. (NOTE: The assumption here is that A/P represents only expenditures for materials, etc., used to produce inventory. If A/P increases, we charged new items to be paid for in a later period. If A/P decreases, we paid out more than we charged.) This new total will represent the cash expenditures for inventory, adjusted for changes in A/P.

          d)  Other Operating Expenses:  Calculate the amount of expenses actually paid during the current period. Assume that all expenses pass through an associated payable account (i.e., Salaries Expense —> Salaries Payable).

Formula: (Use this one when all given information is in Credit (CR) column)

Beginning Balance
+  Expense
<Ending Balance>
Cash Payment

Step 3:  Address any cash payments listed in "Additional Information" (generally taken from notes to financial statements), using one of the above formulas.  (Watch for Investing and Financing activities.)

Step 4:  Check Balance Sheet for any accounts not already addressed and checked off. Disregard "Retained Earnings" (we addressed the revenues and expenses directly), and any Accumulated Depreciation accounts (non-cash). Most of these accounts not already addressed will be Investing and Financing activities.

Step 5:  Verify that Ending Cash Balance as calculated on Statement of Cash Flows reconciles back to ending Cash account balance on Balance Sheet. (NOTE: This is your cross-check -- do NOT simply copy amount from one statement to the other!)

Tips & Tricks for Indirect Method

Note that this is the "simpler" method used by
approximately 95% of actual companies.

Step 1: Calculate the difference between the beginning and ending balances for all Balance Sheet accounts, jotting down to one side.

(NOTE: Remember that only the "Operating Activities" section will differ from the direct method.)

Step 2: Begin the indirect method Statement of Cash Flows with the Net Income. Adjust this amount for any non-cash items included on the Income Statement (i.e., Depreciation Expense, Gains, Losses, etc.). To make these adjustments in the "Operating Activities" section, process all differences calculated between beginning and ending balances on the Balance Sheet according to the following three rules:

RULES: (For use ONLY in the Operating Activities of the statement prepared using the indirect method)

#1:  Deduct increase in Current Assets
       Add decrease in Current Assets

#2:  Deduct decrease in Current Liablities
       Add increase in Current Liabilities

#3:  Deduct all non-cash revenue and gains
       Add all non-cash expenses and losses

Step 3:  Proceed with Investing and Financing Activities sections of statement as noted above in steps 3 through 5.

Where's the Cash?

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