Lesson 5 of 6 · 12 min
Converting the indirect method to the direct method
Most companies publish only an indirect cash flow statement, but in three steps an analyst can turn it into an approximate direct-method statement that shows cash collected and cash paid line by line.
In short
- Why convert: to follow trends in gross receipts and payments, such as cash from customers versus revenue or cash to suppliers versus COGS.
- Step 1: split net income into total revenues and total expenses.
- Step 2: remove non-cash and non-operating items (depreciation, gains, losses) and break the rest into revenue, COGS, wages, other expenses, interest and taxes.
- Step 3: turn each accrual amount into cash using the working capital changes shown in the indirect statement.
- The result is an approximation, good enough for most analysis, and its total equals the reported CFO.
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