As you know, in the case where you prepare your statement of cash flows using the indirect method, the operating profit you start from does include non-cash related expenses. We do mean non-cash in a way that they aren’t accrued expenses or payables on your balance sheet. The most clear example of those expenses is the depreciation. You have paid once for the assets (the outflow of which was presented as a part of investing activities for the year they were acquired) and all the rest is just a non-cash depreciation. As we are preparing the statement of cash flows though, those expenses should be removed or added back (depends on how you look at this) to the profit.

Before we start applying the changes in balances and inventory to the profit to reach operating cash flows, the first thing we should do is adjust the profit so it doesn’t include any non-cash related items. How we do it, is simple. We have our net or operating profit and we just add back the non-cash movement (or take off if it is income). So in case of the depreciation, if our profit was 100 and our depreciation 20, our adjusted profit on the statement of cash flows would add up to 120. Now in case 30 of that profit is non-cash (i.e., we valued up an asset), it should be removed, so we’d reach to 90 as our adjusted operating profit we’d then start using as the base for the operating cash flows.

Remember, if your statement of cash flows isn’t adding up – just go back to your operating profit and make sure you’ve adjusted all non-cash related items.