X. Direct Method

The direct method, although less popular, is favored by many financial managers because it reports the source of cash inflows and outflows directly, without the potentially confusing adjustments to net income. Instead of starting with a reported net income, the direct method analyzes the various types of operating activities and calculates the total cash flow created by each one. Before beginning the direct method, all accrual accounts must first be converted to a cash figure.

XI. Sample Direct Method Worksheet
This worksheet will help explain how the amounts were determined in the direct method cash flow statement (see Statement).

A. Cash receipts from customers:
      Net Sale
      +Beginning Accounts Rec. (1/1/00)
      -Ending Accounts Rec. (12/31/00)
      Cash Receipts from Customers

B. Cash payments for inventory:
      +Ending Inventory (12/31/00)
      -Beginning Inventory (1/1/00)
      +Beginning A/P (1/1/00)
      -Ending A/P (12/31/00)
      Cash paid for inventory


C. Cash paid for operating expenses:
      Operating expenses
      -Depreciation expense
      +Ending prepaid expense
      -Beginning prepaid expense
      +Beginning expense payable
      -Ending expense payable
      Cash paid for operating expenses

D. Cash paid for interest expense:
      Interest expense per P&l
      +Beginning interest payable
      -Ending interest payable
      Cash paid for interest expense

E. Cash paid for corporate income taxes
      Income taxes expense per P&L
      +Beginning taxes payable
      -Ending taxes payable
      Cash paid for corporate taxes

Use this table to practice:
DIRECT METHOD
XYZ COMPANY
STATEMENT OF CASH FLOW
FOR THE YEAR ENDED DECEMBER 31, 2002

CASH FLOWS FROM OPERATING ACTIVITIES
Cash receipts from customers..     

Cash payments for inventory..     

Cash paid for operating expenses..     

Cash paid for interest expense..     

Cash paid for corporate income taxes..     

Net cash provided (used) by operating activities..     


XII. Errors
Common problems encountered in preparing a cash flow statement stem from trade-ins on equipment or from the preparer’s failure to adjust net income by the gain or loss from the sale of equipment.

XIII. Resources
Statement of Financial Accounting Standard No. 95 "Statements of cash flows"

Books
Fred Skousen et al., "Intermediate Accounting" (south-Western Pub., 2000)

Magazines
Journal of Accountancy
The Practical Accountant