Understanding the Cash Flow Statement
The cash flow statement is the financial statement which provides information beyond what is available in other financial statements i.e, Income Statement and Balance Sheet. Cash Flow Statement provides following information to its users:
- Complete information about the company’s cash receipts and cash payments during an accounting period.
- Information about a company’s operating, investing and financing activities.
- An understanding of the impact of accrual accounting events on cash flow.
There are two methods relating to payment of cash flow statements, namely:
- Direct Method
- Indirect Method
Although, both the methods are permitted under US GAAP and IFRS and the difference in the two methods is related to cash flow from operation while the presentation of cash flows from investing activities and cash flow from financing activities is exactly same under both the methods. Following is the detailed explanation of the two methods of preparation of cash flow statement:
Direct Method:
Under the direct method, each line item of the accrual based income statement is converted into cash receipts or cash payments. Unlike accrual method, where the timing of the cash receipts and revenue recognition may differ, direct method simply converts the accrual basis income statement into a cash basis income statement. Below is an example of Direct Method of Preparing Cash Flow from Operating Activities:
In conclusion, direct method begins with the cash inflow from customers and then deducts cash outflows for purchases, operating expenses, interest and taxes.
Indirect Method:
Under this method, the cash flow from operating activities begins with Net Income and by making adjustments for transactions that affect net income but are not cash transactions. These transactions include eliminating non-cash expenses i.e depreciation and amortization, non-operating items and changes in working capital balances i.e Current Assets and Current Liabilities. Below is an example of Indirect Method of preparing Operating Cash Flow:
Important to note that, while Direct Method begins with Revenue adjusted for cash received from customers, Indirect Method begins with Net Income. Total cash flow from operations is same under both the methods, only the presentation method differs.
Amazon Inc: Cash Flow Analysis
Referring to SEC-10K filing of the company, it can be inferred that the company is following indirect method of preparing cash flow statement. Since the Cash Flow Statement began with Net Income, it was a clear evidence that the company is Indirect Method. Furthermore, all the steps relating to Indirect Method were followed. Depreciation and other non-operating expenses were added to Net income which was followed by changes in Current Assets and Liabilities. By the end of 2012, the Cash Flow from Operating Activities were reported to be $4180 Million.
Works Cited
Amazon Inc. SEC 10-K Filing, 2011. Annual Filing. North Seattle: Amazon Inc, 2011.
Grewal, TS. "Financial Accounting." Grewal, TS. Advanced Accoutning. New Delhi: Sharma, 2008. 121-126.
Robinson, Thomas. "Understanding Cash Flow Statement." Institute, CFA. Financial Reporting and Analysis. Boston: Custom, 2011. 103-106.
