On the statement of cash flows under operating activities you have the “changes in receivables”, “changes in inventory” etc. When you see those lines, you know the cash flows are presented using the indirect method. The direct method is always used for investing and financing activities, but can be used for operating as well. However, as the direct method is fairly simple, with this post we are going to explain the logic behind the indirect method.

First and foremost, the “changes in” are disclosed for those areas which are directly connected to operations – receivables, inventory and payables. They are those balances, which are affected by revenue, cost of goods sold, operating expenses etc.

In essence, they act sort of similar to those “paid” and “received” amounts on the statement. For them you start from the brought forward balance, add expenses or income and subtract the carried forward balance. What the changes are, are in essence the difference between the brought forward and carried forward balance. If you add to this the operating profit it all starts from (sum of incomes and expenses) you reach the same result as you would with the direct cash movements. The formula in a way is the same – you have the brought forward, the income or expense from the income statement and the carried forward balance – just the presentation is different.

Considering the above you basically reach to the one result – net inflow or outflow from operating activities. Kind of like if you paid yourself for the operations or were you paid.