Convert cash flow from the indirect to the direct method

Combination of the income statement and a statement of cash flows under the indirect method 

  • Adjust each income statement item for its corresponding balance sheet account
  • Eliminate non-cash and non-operating transactions

Cash collections from customers

  • Begin with Sales from income statement (this is recognized, not necessary realized)
  • Subtract any increase in accounts receivable
  • Add an increase in unearned revenue

Cash payment to suppliers 

  • Begin with cost of goods sold (COGS)
  • If depreciation have been included in COGS this must be added back to cash paid to suppliers
  • Reduce COGS by any increase in accounts payable
  • Add increase in inventory in balance sheet 
  • Subtract inventory write-off that occurred during this period 


  • Inventory write-off
    • Apply the lower of cost or market rule
    • Reduce ending inventory and increase COGS
    • No cash flow associated with the write-off