Hello Friends, I hope this post finds you doing well. It is one of those “a bit under the weather” days for me and today’s closure of the cash flow from operations theme will be relatively brief.

The previous post in this series emphasized that almost all companies provide the Statement of Cash Flows (SCF) following what’s called the “indirect method” of presentation. The indirect method differs from the direct method with regard to one of the SCF’s three sections, namely cash flow from operations. The operating activity section of the SCF, prepared using the indirect method, results from the method’s bottom to top (who reads bottom to top?) application. Recall that the indirect method takes the accrual bottom line net income from the Income Statement and through a series of additions and subtractions essentially converts the accrual net income number into an operating cash income number. However, the additions and subtractions shown under the indirect method aren’t actual cash flows, meaning that there are no actual cash flows revealed under the operating section of the SCF.

The direct method does however show the actual operating cash flows. It is rarely used but is straightforward and readable. I’ll leave you to speculate whether corporate America really wants investors to get a straightforward look at its checkbook from running the business — or perhaps opts to leave investors either guessing or with additional legwork to determine the cash flows. Determining the cash flows can be done but is beyond the scope of my blog posting. I have provided links in former posts to helpful information. Of course, you can google for  “how to” information on direct cash flow presentation. The direct method entails taking the balance sheet and the income statement and using information from these two reports to build a top to bottom cash income report. That report is what you’d see on the SCF if a company was presenting cash flow activity from operations according to the direct approach. You’d actually see line items like “cash collected from sales,” “cash paid to suppliers of inventory,” etc. You sure won’t see such straightforward line items on the SCF under the indirect presentation format.

Depending on what kind of cash analysis you are doing and/or if you see red flags (e.g., net income rising rapidly for several years while over the same course of time cash from operations is rising slowly or even flat to declining), you may want to do further reading and watch videos on “how to” prepare the cash flow from operations under the direct method. I hope this series has helped some.

Until next time,

Paul