Lesson 3 of 6 · 14 min
Operating cash flow: the indirect method
The indirect method starts from net income and undoes everything that is not operating cash: it adds back non-cash expenses, removes non-operating gains and losses, and adjusts for changes in working capital.
In short
- Start with net income, then make three kinds of adjustment: non-cash items, non-operating gains and losses, and changes in operating working capital.
- Add back depreciation, amortisation, depletion and bond discount amortisation; subtract bond premium amortisation.
- Losses on asset sales or debt retirement are added back; gains are subtracted. The cash from the sale belongs in investing (or financing).
- Current operating assets: increase → subtract, decrease → add. Current operating liabilities: increase → add, decrease → subtract.
- An increase in a deferred tax liability is added; equity-method income is subtracted (equity-method losses added).
- Direct and indirect give the same CFO; only the presentation differs. The indirect method is the more common.
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