How do I build cash flow from operations using the indirect method without getting lost?

Question

AcadiFi · Accepted Answer

Under the indirect method, you start with net income and convert accrual earnings into cash from operations. Add back noncash expenses such as depreciation, amortization, and bad debt expense. Then adjust for gains and losses tied to investing or financing items. Finally, handle working capital. An increase in an operating asset uses cash, while an increase in an operating liability provides cash.

Example: Northgate Components reports net income of $320,000. Depreciation expense is $70,000. Gain on sale of equipment is $12,000. Accounts receivable increased by $28,000, inventory decreased by $16,000, prepaid insurance increased by $4,000, and accounts payable increased by $22,000. Cash from operations is $320,000 + $70,000 - $12,000 - $28,000 + $16,000 - $4,000 + $22,000 = $384,000.

```mermaid
flowchart TD
  A[Net income] --> B[Add noncash]
  B --> C[Remove gains]
  C --> D[Adjust assets]
  D --> E[Adjust liabilities]
  E --> F[CFO]
```

A useful memory tool is assets move opposite cash and liabilities move with cash. If receivables rise, more revenue was booked than collected, so subtract it. If payables rise, expenses were recognized without paying cash yet, so add it. On the CPA exam, do not mix operating working capital with notes payable or dividends payable, which are financing items. Practice more in our CPA FAR question bank.

How do I build cash flow from operations using the indirect method without getting lost?

Master FAR with our CPA Course

Related Questions

Practice Questions