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Using the Indirect Method to Prepare a Cash Flow Statement

Preparing a cash flow statement is essential to understanding the financial status of your business. But which is the right way to prepare it: the direct or indirect method?

By Hannah Donor • Nov 9, 2023

A cash flow statement is one of the primary resources used to assess a business’s financial performance, and you can prepare it using either the direct method or the indirect method. Because the indirect method utilizes existing financial documentation, it is generally simpler to prepare and therefore widely preferred by businesses and accountants.

What is a Cash Flow Statement?

A cash flow statement (CFS) is a financial document that businesses use to measure incoming and outgoing cash and cash equivalents (CCE) over a set period of time. A cash flow statement is important for internal purposes, as it enables you to evaluate the financial health of your business and can help guide strategy. A CFS also serves an important purpose externally, like demonstrating your business’s ability to pay debts and expenses to potential investors or lenders. 

Cash flow statements have three main components:

  1. Operating activities: Incoming or outgoing cash related to business operations, such as the production and distribution of products and services.
  2. Investing activities: Incoming or outgoing cash related to long-term assets and investments, such as loans, securities, and capital expenditures.
  3. Financing activities: Incoming or outgoing cash related to funding, e.g. equity, dividends, and debt.

A cash flow statement is not the same as a profit and loss statement, which measures profitability rather than cash on hand. A profit and loss statement tells lenders and investors what your business’s potential profit is, whereas a cash flow statement demonstrates your current financial situation.

What is the Indirect Method of a Cash Flow Statement?

The indirect cash flow method uses accrual accounting—adding together all of your income and expenses for a specific accounting period—to create a cash flow statement based on historical data rather than real-time finances. Starting with your business’s net income, the indirect method adds additional income and subtracts expenses to determine your cash flow.

Indirect Method: Pros

  • Easier to prepare as it utilizes existing financial documents
  • Does not require income to be paid before accounting for it
  • Based on accrual accounting, which most businesses already use
  • Allows credit transactions and depreciating assets to be considered

Indirect Method: Cons

  • May not accurately represent the current cash flow of a business due to its reliance on historical data
  • Only shows cash flow for a select period of time (a limitation of all cash flow statements)
  • Lack of detail means less transparency regarding specific cash transactions and sources

Direct vs. Indirect Cash Flow Methods

Cash flow statements can alternatively be prepared using the direct method, which utilizes cash accounting rather than accrual accounting. The direct method is more complex and time-consuming, as it requires a business to calculate each individual cash transaction rather than basing cash flow on existing balance sheets and income statements.

Unlike the indirect method, which bases cash flow on when cash is earned (accrual accounting), the direct method bases it on when cash is received (cash accounting). Accrual accounting relies largely on payment terms to determine when cash will be earned, rather than waiting for cash to actually be deposited into a bank account.

While the direct cash flow method may more accurately reflect your real-time cash flow, the resulting cash flow statement usually doesn’t differ significantly from an indirect statement. This, combined with the added complexity of the direct cash flow method is why most businesses and accountants prefer the indirect method for preparing cash flow statements.

How to Prepare a Cash Flow Statement Using the Indirect Method

An indirect cash flow statement is relatively simple to prepare, making it the ideal method for single business owners and small businesses as well as larger businesses with several moving parts. Indirect cash flow statements are even easier to create if you use accounting software that helps track your income and expenses. With Lili’s Accounting Software, not only can you instantly categorize your income and expense transactions, but your cash flow statement is automatically generated for you, making your reporting that much simpler. 

The following is a step-by-step guide to preparing a statement of cash flows using the indirect method:

1. Collect Necessary Financial Documents

Start by gathering all of the financial documents you need to calculate your cash flow. The two main documents you will need are:

  • A balance sheet that shows assets and liabilities
  • An income statement that lists expenses and revenue

These documents should contain financial information specifically related to the year, quarter, or another period of time (accounting period) for which you are creating a cash flow statement.


Sam owns a local music store. She wants to determine her cash flow using the indirect method and base it on last year’s finances. She starts by collecting her balance sheet and income statement for the previous year (the accounting period), which she will pull information from to create a cash flow statement.

2. List the Net Income

Using your income statement, list the net income for the relevant accounting period. This should go on the first line of your cash flow statement, demonstrating your initial income before considering operating, investing, and financing activities.


Using her income statement for the accounting period, Sam determines her net income was $10,000. She lists this figure at the top of her cash flow statement.

3. Input and Calculate Operating Activities

List cash and non-cash income and expenses on your cash flow statement, then total these adjustments as “net cash from operating activities.” These may include ordering supplies and inventory. 


Based on her balance sheet, Sam determines that her fixed assets depreciated by $500. Her accounts payable (outgoing cash or expenses) showed a decrease of $20,000, but her accounts receivable and inventory show an increase in her assets of $25,000. By subtracting decreases and depreciations and adding asset increases, Sam lists her net cash from operating activities as $14,500 in cash and cash equivalents (i.e. inventory).

4. Add Investing Activities

Line by line, list all cash gained or lost through investing activities. These include the purchase and sale of stocks, securities, or loans; as well as the purchase or sale of any long-term assets. Total these items as “net cash from investing activities.”


Sam may not buy or sell stocks, but she did purchase a property and furnishings when she opened her music store last year. These purchases totaled $100,000 – which she lists as her net cash for investing activities.

5. Add Financing Activities

Outline any cash collected from or paid to finance activities such as equities, dividends, and loans. List the total as “net cash used in financing activities.” If any payments were made toward outstanding debts, these should be subtracted from your total financing activities before totaling your net cash.


To open her business, Sam took out a property loan of $80,000 to purchase her storefront and a small business loan of $15,000 to cover the purchase of furnishings, inventory, and supplies needed to set up and open her music store. This means her net cash used in financing activities was $95,000, as she did not begin making payments toward these loans for the first year of business.

6. Calculate the Net Total

Add net cash from operating activities and investing activities (subtracting any negative figures), then subtract net cash used in financing activities to determine your net increase or decrease in cash (net total).


Sam adds together her net income from operating activities and investing activities, then subtracts the net cash used in financing activities:

$14,500 + $100,000 – $95,000 = $19,500

7. Calculate Net Cash Flow

Add the net total to your net income (if it’s a negative number, it will decrease your total) to get net cash flow. This is your final cash balance. A positive number reflects a healthy cash flow, whereas a negative number may be a sign of unsustainable cash flow.


Sam adds her net income from line 1 of her cash flow statement ($10,000) to the net total ($19,500):

$10,000 + $19,500 = $29,500 final cash balance

What if My Final Cash Balance is Negative?

If your cash flow statement reveals a negative final cash flow, your business may indeed be losing money and should consider adopting cost-cutting measures

However, bear in mind that if you’ve used the direct cash flow method, the result could also simply be the timing of various income and expense sources during that accounting period. For example, if a customer has a large outstanding invoice that is not paid during the cash flow accounting period, but you have to cover a number of bills during that same period, this may account for the negative cash flow. Using the indirect method accounts for earnings to be received (such as inventory and other cash equivalents), so ultimately a negative cash flow may not be the actual representation of your current business cash flow.

Indirect Method of Cash Flow Statement FAQs

What is the difference between indirect and direct cash flow statements?
Why is the indirect method of preparing a cash flow statement better?
When should a cash flow statement be prepared?

Written by

Hannah Donor is a freelance copywriter and social media strategist with 5+ years of experience helping small businesses authentically curate the written word to reach and inspire their target market.