Meet Alex. Founder of a growing e-commerce business. His income statement was a thing of beauty – profit, profit, and more profit. But his bank account was telling a much different, much scarier story.

Cash was always MIA. Making payroll felt like a high-stakes poker game, and paying suppliers on time was a constant source of that cold-sweat kind of stress. On paper, Alex was killing it. In reality, he was about to fall off a cash-flow cliff.

This chasm between the profit you report and the cash you have is a silent killer for countless businesses. The tool that builds a bridge over that chasm, giving you a real, honest look at your financial health, is the indirect cash flow statement.

So, What Exactly is an Indirect Cash Flow Statement?

Think of the indirect cash flow statement as your business’s financial health report card. It’s a vital tool for assessing a company’s liquidity and operational efficiency. A common misconception is that it directly tracks every dollar. Instead, it cleverly starts with your net income and then adjusts for all the non-cash stuff (like depreciation) and shifts in working capital to show you the real cash situation.

This method is favored by a staggering number of businesses, not because it’s the most detailed – in fact, the Financial Accounting Standards Board (FASB) actually prefers the direct method for its clarity – but because it’s practical. It reconciles your accrual-based accounting with your actual cash flow, revealing your true financial footing.

It All Starts with Accrual Accounting

The indirect method is built on accrual accounting, where you log revenue when you earn it, not necessarily when the cash lands in your account. This gives you a great, big-picture view of performance, including credit sales.

But here’s the catch: because it includes non-cash items like sales on credit (accounts receivable), it can mask your immediate cash reality. That’s precisely why a dedicated cash flow statement is non-negotiable.

The Three Pillars of Cash Flow

To make sense of it all, the indirect cash flow statement format breaks everything down into three core components. Understanding these cash flow statement components is key to seeing where your money is really coming from and going.

• Cash Flow from Operating Activities: This is the cash generated or burned by your main business operations. It’s the financial pulse of your company.
• Indirect Method Cash Flow Investing Activities: This tracks money made or spent on investments. Think selling old equipment, buying another company’s stock, or purchasing a new building.
• Indirect Method Cash Flow Financing Activities: This is all about the cash moving between the company and its owners or creditors. We’re talking about issuing stock, paying back a loan, or giving out dividends.

Direct vs. Indirect Method: Why You’ll Probably Use This One

So, you have two choices for this whole cash flow statement thing: direct and indirect. Let’s get real about the difference between direct and indirect cash flow statement.

• The indirect method starts with net income (from your income statement) and works backward to adjust for non-cash items.
• The direct method skips net income and just lists all the cash that came in and all the cash that went out. Simple, right?

So why do most businesses choose the indirect method? Of course, accountants prefer the ‘indirect’ cash flow method. Why track actual money in and out when you can just reverse-engineer it from reports already designed to obscure the truth? It’s ‘efficient,’ which is corporate speak for ‘less work, more plausible deniability.’

Seriously, though. The information needed for the indirect method cash flow statement is easily pulled from your existing income statement and balance sheets. The direct method requires you to track every single cash transaction, which can be a massive pain. While both get you to the same final number, one is a scenic country road and the other is a 12-lane highway during rush hour. You choose.

How to Prepare an Indirect Cash Flow Statement: A Step-by-Step Guide

When a task involves pulling many pieces together and making adjustments, it can feel like a lot to navigate. It’s okay to take your time with each step. Remember that even the most systematic processes unfold one careful adjustment at a time.

Here’s how to prepare an indirect cash flow statement.

Step 0: Get Your Docs in a Row

Before you do anything, you need two things:

• Your income statement for the period.
• Comparative balance sheets (one from the beginning of the period, one from the end).

Step 1: Start with Net Income

Easy peasy. Grab the net income from the bottom of your income statement. This is your starting point.

Step 2: Adjust for Non-Cash Items

Now, you need to add back expenses that didn’t actually use cash and subtract gains that weren’t from your core operations.

• Add back non-cash expenses: Things like depreciation and amortization reduced your net income on paper, but no cash left your bank account. Add them back.
• Subtract non-cash gains / Add back losses: If you sold an old truck for a profit, that gain artificially inflated your net income. You’ll account for the actual cash from the sale in the investing section, so subtract the gain here to avoid counting it twice. Conversely, add back any losses.

Step 3: Adjust for Changes in Working Capital

This is where you reconcile the difference between accrual accounting and cash reality.

• Subtract increases in operating assets: If your accounts receivable went up, it means you made sales but haven’t been paid yet. That’s a use of cash (in a sense). Same with inventory – you spent cash on products you haven’t sold.
• Add decreases in operating assets: If your accounts receivable went down, it means you collected cash. Cha-ching!
• Add increases in operating liabilities: If your accounts payable went up, you got goods or services but haven’t paid for them yet. This conserves your cash.
• Subtract decreases in operating liabilities: If your accounts payable went down, it means you paid your bills, which is a use of cash.

Step 4: Calculate Net Cash from Operating Activities

Sum up your net income and all the adjustments from Steps 2 and 3. This gives you your cash flow from operating activities indirect method subtotal. This number is gold – it tells you if your core business is a cash-generating machine or a cash-burning furnace.

Step 5: Account for Investing Activities

Here, you’ll detail the cash flow from buying and selling long-term assets.

• Add cash inflows: Cash from selling property, equipment, or other investments.
• Subtract cash outflows: Cash spent to buy property, equipment, or other long-term assets.

Step 6: Account for Financing Activities

This section covers cash flow between you, your owners, and your lenders.

• Add cash inflows: Cash from issuing stock or taking on debt.
• Subtract cash outflows: Cash used to pay dividends, buy back stock, or repay the principal on loans.

Step 7: The Grand Finale: Net Change in Cash

Time to bring it all home.

• Sum the net cash totals from operating, investing, and financing activities. This is your net increase or decrease in cash for the period.
• Add this net change to your beginning cash balance (from your start-of-period balance sheet).
• The result is your ending cash balance. This number MUST match the cash balance on your end-of-period balance sheet. If it does, congratulations – you just prepared a cash flow statement using the indirect method.

Example of Indirect Cash Flow Statement: Making It Real

Let’s look at a sample to see how these numbers actually play out. The following table provides a clear example of indirect cash flow statement calculations.

INDIRECT CASH FLOW STATEMENT	Debit ($)	Credit ($)
Net income		3,500,000
Cash flows from operating activities
Adjustment for:
Depreciation and amortization	120,000
Provision for losses on accounts receivable	45,000
Gain on sale of asset	(65,000)	100,000
Increase in trade receivables	(200,000)
Decrease in inventory	350,000
Decrease in trade payables	(25,000)
Cash generated from operations		3,725,000
Cash flow from investing activities
Purchase of property, plant & Equipment	(550,000)
Proceeds from the sale of equipment	65,000
Net cash used in investing activities		(485,000)
Cash flow from financing activities
Proceeds from the issue of common stock	160,000
Proceeds from the issuance of long-term debt	185,000
Dividends paid	(65,000)
Net cash used in financing activities		280,000
Net increase in cash & cash equivalents		3,520,000
Cash and cash equivalents at the beginning of the period		1,480,000
Cash and Cash equivalents at the end of the period		5,000,000