Indirect method vs Direct method Statement of Cash Flows

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Likewise, decreases in the current liabilities are recorded as decreases in the company’s cash inflows. In addition, the indirect method begins with the income statement’s net income data. Further, noncash deductions are added back to the net income to arrive at the correct cash inflow (Stickney, 2009). For example, the income statement shows a deduction for depreciation expense. Since the indirect methods starts with the net income, the depreciation expense reduced the company’s net income amount. Consequently, the proper process is to add back the depreciation expense to the net income. The reason is very obvious. All company expenses have a correspondent credit to cash or cash equivalents. However, there was no cash outflow or payment made when the company debited depreciation expense. To arrive at the amount of cash that flowed into the company’s coffers, the next step is to add back the cash-absent depreciation expense. The same process is applied to the amortization expense. Amortization expense is debited but there is no corresponding credit to cash or cash equivalents…. There is a big difference between the cash inflows from operating activities and the cash inflows from investing activities. The cash inflows from operating activities represent the cash inflows that come from the normal day to day business operations. For example, the company is engaged in the selling of television sets. Cash inflow figure comes from the day to day selling of the televisions sets. In terms of the company’s cash outflows come from the purchase of the television sets from the television store’s suppliers. If the company is a barber shop, the company’s cash inflows come from the customers who pay for their haircuts. The company’s cash outflows include the amounts paid for the electricity that is used to light the barbershop (Stickney, 2009). The cash inflows from investing activities represent just what account states. The amount represents cash inflows and cash outflows from non-operating activities. For example, the grocery company buys store inventory. The amount paid for the store inventory is part of cash inflows from operating activities. The company buys the inventory in order to sell the inventories to their current and prospective customers. On the other hand, the company buys the adjacent building. The amount paid for the building is classified as cash outflows from investing activities. The company is investing in the building because the company wants to expand the grocery business. When the company sells its old grocery building at a discounted price, the amount collected is classified as cash inflows from investing activities. The company decides to sell the old grocery building, which was originally recorded as cash outflows from investing activities, when the old grocery building was purchased. In the same