(134)-CASH FLOW STATEMENTS - INDIRECT METHOD

Cash Flow Statements -Indirect Method

Another way of arriving at net cash flows from operating activities is to start from operating profit and adjust non cash items, such as depreciation, debtors etc. This is known as the indirect method.

A Proforma calculation is given below.

Operating profit-----------------------------------------------------XXX
(Add)- Depreciation-----------------------------------------------XXX
Loss/Profit on sale of fixed assets-------------------------XXX
Increase/Decrease in stocks---------------------------------XXX
Increase/Decrease in debtors--------------------------------XXX
Increase/Decrease in creditors-----------------------------XXX
NET CASH FLOW FROM OPERATING ACTIVITIES--XXX

It is important to understand why certain items are added and other subtracted. Note the following points.

• Depreciation is not a cash expense, but deducted in arriving at the profit figure in the profit and loss account. It makes sense, therefore, to eliminate it by adding it back.
• By the same logic, a loss on a disposal of fixed asset needs to be added back and profit deducted.
• An increase in stocks means less cash, you have spent on buying stock.
• An increase in debtors means debtors have not paid as much, therefore less cash.
• If we pay off creditors, causing the figure to decrease to decrease, again we have less cash.