Indirect Method for Reporting Cash Flow from Operations

C

Under the indirect method the starting point is the period's net income.

Under the indirect method of reporting cash flows from operations, the starting point is the net income.

Net income is the bottom line of the income statement and represents the profit or loss generated by a company during a specific period. It is calculated by subtracting total expenses from total revenues.

The indirect method focuses on adjusting the net income to arrive at the cash flow from operating activities. The objective is to convert the accrual basis net income to a cash basis, as net income includes non-cash items such as depreciation, amortization, and changes in working capital.

To arrive at the cash flow from operations using the indirect method, the following adjustments are made to the net income:

1. Add back non-cash expenses: Non-cash expenses, such as depreciation and amortization, do not involve the outflow of cash. Since they are included in the net income, they need to be added back to arrive at the cash flow from operations.

2. Adjust for changes in working capital: Changes in working capital include changes in current assets (such as accounts receivable, inventory, and prepaid expenses) and current liabilities (such as accounts payable and accrued expenses). An increase in current assets uses cash, while an increase in current liabilities provides cash. Therefore, an increase in current assets is subtracted, and an increase in current liabilities is added to the net income.

The adjustments for changes in working capital ensure that the cash inflows and outflows related to operating activities are captured in the cash flow statement.

Once these adjustments are made, the resulting figure represents the cash flow from operating activities under the indirect method.

In the given options, the correct answer is:

C. Net income

Net income is the starting point for calculating the cash flow from operations under the indirect method. The adjustments mentioned above are made to the net income to convert it from an accrual basis to a cash basis and arrive at the cash flow from operating activities.