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How To Prepare a Cash Flow Statement 
 
by kmhagen June 21, 2005

Direct Method

Under the direct method, you are basically analyzing your cash and bank accounts to identify cash flows during the period.  You could use a detailed general ledger report showing all the entries to the cash and bank accounts, or you could use the cash receipts and disbursements journals.  You would then determine the offsetting entry for each cash entry in order to determine where each cash movement should be reported on the cash flow statement.

Another way to determine cash flows under the direct method is to prepare a worksheet for each major line item, and eliminate the effects of accrual basis accounting in order to arrive at the net cash effect for that particular line item for the period.  Some examples for the operating activities section include:

Cash receipts from customers:

  • Net sales per the income statement
  • Plus beginning balance in accounts receivable
  • Minus ending balance in accounts receivable
  • Equals cash receipts from customers

Cash payments for inventory:

  • Ending inventory
  • Minus beginning inventory
  • Plus beginning balance in accounts payable to vendors
  • Minus ending balance in accounts payable to vendors
  • Equals cash payments for inventory

Cash paid to employees:

  • Salaries and wages per the income statement
  • Plus beginning balance in salaries and wages payable
  • Minus ending balance in salaries and wages payable
  • Equals cash paid to employees

Cash paid for operating expenses:

  • Operating expenses per the income statement
  • Minus depreciation expenses
  • Plus increase or minus decrease in prepaid expenses
  • Plus decrease or minus increase in accrued expenses
  • Equals cash paid for operating expenses

Taxes paid:

  • Tax expense per the income statement
  • Plus beginning balance in taxes payable
  • Minus ending balance in taxes payable
  • Equals taxes paid

Interest paid:

  • Interest expense per the income statement
  • Plus beginning balance in interest payable
  • Minus ending balance in interest payable
  • Equals interest paid

Under the direct method, for this example, you would then report the following in the cash flows from operating activities section of the cash flow statement:

  • Cash receipts from customers
  • Cash payments for inventory
  • Cash paid to employees
  • Cash paid for operating expenses
  • Taxes paid
  • Interest paid
  • Equals net cash provided by (used in) operating activities

Similar types of calculations can be made of the balance sheet accounts to eliminate the effects of accrual accounting and determine the cash flows to be reported in the investing activities and financing activities sections of the cash flow statement.

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