The statement of cash flows explains the change in cash, cash equivalents and restricted cash in three sections: operating, investing and financing. ASC 230 allows two ways of presenting the operating section. The indirect method starts with net income and adjusts for noncash items and working capital changes. The direct method lists the major classes of gross cash receipts and payments. Almost all entities use the indirect method, but the direct method is encouraged, and when it is used the statement must also include a reconciliation of net income to operating cash flow.
This guide builds both statements from one set of illustrative numbers so you can see exactly how they connect. For the indirect method in depth, see the indirect method guide.
The data
All numbers are illustrative.
Income statement for the year:
| Line | Amount |
|---|---|
| Sales | 1,800,000 |
| Cost of goods sold | (1,100,000) |
| Depreciation | (60,000) |
| Selling, general and administrative | (380,000) |
| Interest expense | (20,000) |
| Gain on sale of equipment | 10,000 |
| Income tax expense | (110,000) |
| Net income | 140,000 |
The check: 1,800,000 - 1,100,000 - 60,000 - 380,000 - 20,000 + 10,000 - 110,000 = 140,000.
Balance sheet changes and other facts:
- Accounts receivable up 40,000. Inventory up 25,000. Prepaid expenses down 5,000.
- Accounts payable (all for inventory) up 30,000. Accrued liabilities (all SG&A) up 12,000. Deferred revenue down 8,000.
- Income taxes payable and accrued interest did not change.
- Equipment purchased for 120,000. Equipment sold for 35,000 at a gain of 10,000.
- New long-term borrowings 100,000; repayments 40,000; dividends paid 30,000.
- Beginning cash 120,000.
Indirect method
| Operating activities | |
|---|---|
| Net income | 140,000 |
| Depreciation | 60,000 |
| Gain on sale of equipment | (10,000) |
| Increase in accounts receivable | (40,000) |
| Increase in inventory | (25,000) |
| Decrease in prepaid expenses | 5,000 |
| Increase in accounts payable | 30,000 |
| Increase in accrued liabilities | 12,000 |
| Decrease in deferred revenue | (8,000) |
| Net cash from operating activities | 164,000 |
Running total: 140,000 + 60,000 - 10,000 = 190,000; less 40,000 and 25,000 = 125,000; plus 5,000 = 130,000; plus 30,000 and 12,000 = 172,000; less 8,000 = 164,000.
The gain is removed because the full 35,000 proceeds belong in investing.
Direct method
The direct method converts each income statement line from accrual to cash.
| Line | Calculation | Cash |
|---|---|---|
| Cash received from customers | 1,800,000 - 40,000 AR increase - 8,000 deferred revenue decrease | 1,752,000 |
| Cash paid to suppliers for inventory | 1,100,000 COGS + 25,000 inventory increase - 30,000 AP increase | (1,095,000) |
| Cash paid for SG&A | 380,000 - 5,000 prepaid decrease - 12,000 accrual increase | (363,000) |
| Interest paid | 20,000 (no change in accrued interest) | (20,000) |
| Income taxes paid | 110,000 (no change in taxes payable) | (110,000) |
| Net cash from operating activities | 164,000 |
Check: 1,752,000 - 1,095,000 - 363,000 - 20,000 - 110,000 = 164,000. The result agrees to the indirect method, as it must. Depreciation and the gain do not appear in the direct method because they are not cash flows.
Investing and financing (same under both methods)
| Investing activities | |
|---|---|
| Purchase of equipment | (120,000) |
| Proceeds from sale of equipment | 35,000 |
| Net cash used in investing | (85,000) |
| Financing activities | |
|---|---|
| Proceeds from long-term borrowings | 100,000 |
| Repayments of long-term debt | (40,000) |
| Dividends paid | (30,000) |
| Net cash from financing | 30,000 |
Net change in cash
| Operating | 164,000 |
| Investing | (85,000) |
| Financing | 30,000 |
| Net increase in cash | 109,000 |
| Beginning cash | 120,000 |
| Ending cash | 229,000 |
The ending figure must agree to the balance sheet and the cash account in the trial balance, including any restricted cash, which ASC 230 requires in the beginning and ending totals.
The reconciliation and required disclosures
If a company presents the direct method, ASC 230 requires a separate reconciliation of net income to net cash from operating activities, which is the indirect schedule above. If it presents the indirect method, it must disclose interest paid (net of amounts capitalized) and income taxes paid, either on the face of the statement or in the notes (ASC 230-10-50-2). In the example, those are 20,000 and 110,000.
Noncash investing and financing activities, such as equipment acquired with a note or a lease right-of-use asset obtained in exchange for a lease liability, are disclosed separately and not in the body of the statement.
Classification quick reference
| Item | Section |
|---|---|
| Receipts from customers; payments to suppliers and employees | Operating |
| Interest paid and taxes paid | Operating (ASC 230-10-45-17) |
| Interest and dividends received | Operating (ASC 230-10-45-16) |
| Purchase or sale of property and equipment | Investing |
| Loans made and collected | Investing |
| Proceeds from borrowing and repayment of principal | Financing |
| Dividends paid and repurchases of the entity's own shares | Financing (ASC 230-10-45-15) |
Tie-out checks for the file
- Ending cash on the statement agrees to the balance sheet.
- Net income agrees to the income statement and retained earnings rollforward.
- Each working capital change agrees to the balance sheet comparison, adjusted for non-operating items.
- Equipment: beginning cost + purchases - disposals = ending cost, using the fixed asset rollforward calculator if needed.
- Debt: beginning + borrowings - repayments = ending, excluding noncash changes.
- Dividends paid agree to the equity rollforward and cash disbursements.
- The sum of the three sections equals the change in cash.
The cash flow statement template has these checks built into the layout. See trial balance for how the statement ties to the working trial balance.
Common errors
- Reporting the whole sale proceeds in operating activities and leaving the gain in net income.
- Double counting a change in a balance that is part of an investing or financing line, such as accrued interest on debt.
- Showing capex still unpaid at year end as an investing outflow. It is a noncash item until paid.
- Omitting restricted cash from the beginning and ending cash reconciliation.
- Balancing the statement with a plug in "other operating activities".
- Classifying dividends paid as operating.
FAQ
Which method do most companies use?
The indirect method. ASC 230 encourages the direct method, but few entities use it because the data are harder to produce.
Do both methods produce the same operating cash flow?
Yes. They differ only in presentation, and the direct method requires an indirect reconciliation as well.
Where do interest and taxes paid go?
Both are operating cash outflows. Under the indirect method, they must also be disclosed.
Where does the gain on sale of equipment go?
It is removed from operating activities in the indirect method, and the full proceeds are shown in investing.
Can a cash flow statement be skipped?
For GAAP statements, ASC 230 requires one for a full set. Certain entities, such as some employee benefit plans, are exempt. A statement prepared on a tax or cash basis may not need one.
CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.
Sources
- FASB ASC 230-10-45-15, 45-16, 45-17, 45-25 and 45-28 through 45-31; ASC 230-10-50-2 and 50-3; KPMG, Statement of cash flows handbook (2026), chapters 3 and 4
- FASB ASC 230-10-45-4, cash, cash equivalents and restricted cash
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