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Indirect Method of Preparing the Statement of Cash Flows

When preparing the statement of cash flows using the indirect method, the operating section starts with net income from the income statement, which you adjust for any noncash items hitting the income statement. Your three biggies are depreciation, amortization (both of which are noncash transactions), and gain or loss on the disposal of assets.

For the following figure, net income is $95,000, depreciation on PP&E is $4,250, and cash received when selling some equipment results in a gain of $750. Note that the bottom-line net cash provided by operating activities is (and has to be) the same whether you use the direct or the indirect method.

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Gains and losses from the sale of assets usually require adjustments on the statement of cash flows because the gain or loss shown on the income statement for the sale rarely, if ever, equals the cash a company receives for the transaction.

Any differences when using the direct versus the indirect method show up only in the operating section. The investing and financing sections are prepared the same using either method.

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