Which statement is true about the two methods for calculating cash flow from operations?

Which statement is true about the two methods for calculating cash flow from operations?

• A. The indirect method starts from net income and adjusts for non-cash items.
• B. The indirect method starts from profit before tax and adjusts for cash movements; the direct method lists cash inflows and outflows.
• C. The direct method ignores taxes.
• D. There is only one method used in practice.

Answer: (B)

Two methods exist for presenting cash flow from operating activities. The indirect method starts with a reported accounting result (profit before tax) and then adjusts for non-cash items and changes in working capital to convert from accruals to cash. The direct method instead provides a direct listing of actual cash receipts and cash payments from operating activities, such as cash collected from customers and cash paid to suppliers and employees. This is why the statement is true: it correctly describes the indirect method’s starting point and its adjustment process, and it correctly describes the direct method as listing cash inflows and outflows. In practice, both methods are allowed, though many companies use the indirect method because it links to the income statement and balance sheet, and a reconciliation is often provided if the direct method is used.

Two methods exist for presenting cash flow from operating activities. The indirect method starts with a reported accounting result (profit before tax) and then adjusts for non-cash items and changes in working capital to convert from accruals to cash. The direct method instead provides a direct listing of actual cash receipts and cash payments from operating activities, such as cash collected from customers and cash paid to suppliers and employees.

This is why the statement is true: it correctly describes the indirect method’s starting point and its adjustment process, and it correctly describes the direct method as listing cash inflows and outflows. In practice, both methods are allowed, though many companies use the indirect method because it links to the income statement and balance sheet, and a reconciliation is often provided if the direct method is used.