Indirect Method

Driving from New York to Philadelphia via Chicago: the indirect method.

The notion also represents a way companies prepare their cash flow statements. The goal of the cash flow statement is to track how money traveled through the company during a given period of time (and how much the firm kept). The indirect method derives this information by using stats the company keeps for other reasons.

It begins with the firm's net income figure (or a net loss, if it had a bad few months) and then makes adjustments based on non-cash items that impacted the company during the time period. So, instead of starting with the cash that came into the company and subtracting cash that went out, the indirect method effectively starts at the end, looking at the total profit left over after everything got paid. Then it adds back in (or takes back out) any non-cash items that impacted the bottom line (because non-cash items don't impact cash flow, even if they affect net income).

Imagine it this way: you want to know how old someone is. The direct method would be to find out their birth date and subtract that from today's date. However, they're being dodgy about telling you their birthday. But you know their mom is 62 and she gave birth to her kid when she was 30. You can deduce (using a form of the indirect method) that the kid is 32 years old.

Similarly, the accounting version takes a less straightforward approach to get to the same answer. Ironically, though, the indirect method often turns out to be easier (not like the trip from New York to Chicago to Philly). The added simplicity comes because the figures involved all derive from other financial statements. The accountant doesn't have to find out additional information.

As long as the balance sheet and income statement are already prepared, it's just simple math to put together the cash flow statement. Thus, most accountants (wanting to get to happy hour as soon as possible), prefer the indirect method.