Indirect method
AccountingPreparing the cash flow statement by starting at net income and reversing every place where accrual accounting and cash diverged.
Also written: indirect cash flow method, cash flow reconciliation
Under the indirect method the operating section does not measure cash directly. It begins at net income and works backwards, adding back charges that reduced profit without moving cash, subtracting gains that raised profit without producing cash, and adjusting for every change in working capital.
IAS 7 permits either this or the direct method, which lists cash receipts and payments outright, but essentially every listed European reporter chooses the indirect method. The reason is practical rather than conceptual: the indirect version can be built from the income statement and two balance sheets, which a company already has, while the direct version needs the underlying cash records grouped in a way most ledgers are not.
The consequence for anyone reading the statement is that the operating section doubles as a reconciliation. Reading down it tells you not only what cash the business generated but where profit and cash disagreed and by how much, which is far more informative than a list of receipts would be.
It also explains why the answering order in a walkthrough question is forced. A statement that begins at net income cannot be built until the income statement is settled, which is why the cash flow statement is always second and never first.
Worked example
Net income of 150, plus 20 of depreciation added back, less 170 absorbed by a working capital build, gives cash from operations of zero.
The direct method would report the same zero without ever showing that the business earned 150 and lent all of it to its customers and its warehouse. The reconciliation is the useful part.