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.