How to Prepare a Cash Flow Statement Using the Indirect Method

Understanding cash flow is essential for running and advising small- and mid-sized businesses. The cash flow statement provides a clear picture of how cash moves through a company, where it comes from, how it’s spent, and how much is available for operations, investing, and financing. This guide explains how to prepare a cash flow statement using the indirect method, step by step, and highlights practical advisory tools and training that can help professionals turn cash flow work into a profitable recurring service.

Why the Cash Flow Statement Matters

The income statement shows profitability, and the balance sheet shows a company’s financial position at a moment in time. The cash flow statement reveals how cash actually flowed during the reporting period, reconciling those two views. For business owners and advisors, cash flow is often the difference between survival and growth.

Advisors can use the cash flow statement to identify liquidity risks, plan financing needs, and find opportunities to free up “hidden cash.” Programs like those from Cash Flow Mike specialize in uncovering these opportunities and teaching a repeatable advisory approach to cash flow optimization.

At its core, the cash flow statement is divided into operating, investing, and financing activities, each telling a different story. Operating cash flow shows whether the company’s core business generates enough cash to sustain operations; investing cash flow reveals capital expenditures or asset sales that affect long-term capacity; and financing cash flow highlights how the business is funded through debt, equity, or distributions. Understanding the interplay among these sections helps advisors spot common red flags, such as strong reported earnings paired with weakening operating cash flow, escalating capital commitments that outpace cash generation, or recurring reliance on short-term borrowings to cover payroll.

Practical steps derived from the cash flow statement include building a rolling 13-week cash forecast, monitoring cash conversion cycle metrics (days sales outstanding, days inventory outstanding, days payable outstanding), and stress-testing scenarios for slower collections or sudden drops in sales. Simple working-capital levers, such as tightening credit terms, incentivizing faster customer payments, negotiating longer supplier terms, and optimizing inventory turns, can free up significant liquidity. Regularly reviewing the cash flow statement alongside KPIs like cash burn rate and free cash flow makes these opportunities visible and actionable for owners and their advisors.

Overview of the Indirect Method

The indirect method starts with net income from the income statement and adjusts it for non-cash items, changes in working capital, and other cash flows to arrive at cash provided by (or used in) operating activities. Most companies prefer the indirect method because it links net income to operating cash flow in a way that highlights differences caused by accrual accounting.

There are three main sections in a cash flow statement prepared using the indirect method: operating activities, investing activities, and financing activities. Each section serves a distinct purpose and uses specific source data from the balance sheet and income statement.

Operating Activities — Reconcile Net Income to Cash

The operating activities section converts net income into cash generated (or used) by the company’s day-to-day operations. This is where the indirect method does most of its work.

Begin with net income, then make adjustments in three categories:

• Non-cash expenses and gains (e.g., depreciation, amortization, unrealized gains/losses)
• Changes in working capital (e.g., accounts receivable, inventory, accounts payable)
• Other operating cash items (e.g., deferred taxes, provision adjustments)

Step-by-Step Preparation: Operating Activities

Follow these steps using the current and prior period balance sheets and the income statement for the period.

Step 1: Start with Net Income

Take the net income figure from the income statement. This represents accrual-based profit and is the starting point for adjusting to cash flow.

Step 2: Add Back Non-Cash Expenses

Common non-cash expenses include depreciation and amortization. Because these expenses reduce net income but do not use cash during the period, they are added back. Other examples include stock-based compensation and impairment charges.

Step 3: Remove Non-Operating Gains and Losses

If the income statement includes gains or losses from investing or financing activities (such as a gain on the sale of equipment), remove these from operating cash flow. The cash impact of those transactions is reported separately in the investing or financing sections.

Step 4: Adjust for Changes in Working Capital

Working capital adjustments translate accrual-based changes into cash effects. The primary accounts to review are:

• Accounts Receivable: An increase means revenue recorded that hasn’t been collected in cash yet (subtract); a decrease adds cash.
• Inventory: An increase uses cash for additional stock (subtract); a decrease frees cash (add).
• Accounts Payable and Accrued Expenses: An increase means expenses incurred but not yet paid in cash (add); a decrease means cash (subtract).

Calculate each change by subtracting the prior period balance from the current period balance. Apply the sign conventions above to determine the cash effect.

Investing and Financing Activities

After arriving at net cash from operating activities, move to the investing and financing sections. These use direct cash flows from transactions that increase or decrease long-term assets and liabilities.

Investing Activities

Investing activities report cash used to buy long-term assets (such as property, plant, and equipment) and cash received from sales of such assets or from investing transactions like loans to others. Examples include:

• Purchase of equipment or property (cash outflow)
• Proceeds from the sale of assets (cash inflow)
• Purchases or sales of investments (cash flow accordingly)

These items are typically straightforward to extract from the fixed asset changes on the balance sheet and notes to the financial statements.

Financing Activities

Financing activities capture cash flows between the company and its owners or creditors. Look for:

• Issuance or repurchase of stock
• Proceeds from borrowing or repayments of debt
• Dividends paid

Compare long-term liability and equity accounts between periods to identify these cash flows.

Putting It All Together: A Practical Example

Use an example company with the following simplified data to illustrate the indirect method. Assume net income is $120,000, depreciation is $15,000, accounts receivable increased by $10,000, inventory decreased by $5,000, and accounts payable increased by $8,000. The company purchased equipment for $50,000 and repaid $20,000 of long-term debt.

Operating Activities:

• Net income: $120,000
• Add depreciation: +$15,000
• Subtract increase in accounts receivable: -$10,000
• Add decrease in inventory: +$5,000
• Add an increase in accounts payable: +$8,000
• Net cash from operating activities: $138,000

Investing Activities:

• Purchase of equipment: -$50,000
• Net cash from investing activities: -$50,000

Financing Activities:

• Repayment of long-term debt: -$20,000
• Net cash from financing activities: -$20,000

Net change in cash for the period: $138,000 – $50,000 – $20,000 = $68,000

That net change reconciles to the beginning and ending cash balances shown on the balance sheet.

Common Pitfalls and How to Avoid Them

Preparing a cash flow statement can surface nuances that lead to errors if not handled carefully. Attention to detail and a structured approach prevent mistakes.

Mixing Accrual and Cash Items

Ensure all non-cash items are added back to net income. Conversely, do not include accrual-only transactions as cash flows. Maintain a clear separation between accrual adjustments and cash movements.

Miscalculating Working Capital Changes

Always use beginning and ending balance sheet figures to compute changes. Mistakes often happen when interim activity or supplementary schedules aren’t considered. Cross-check calculations against general ledger activity and bank statements when possible.

Incorrect Classification of Activities

Classify cash flows properly: gains or losses on asset sales go to investing activities (cash received or paid shows there), while dividends paid appear in financing. Misclassification distorts analytic insights.

How Advisors Can Turn Cash Flow Reporting into a Recurring Service

Accountants and bookkeepers can transform cash flow preparation from a compliance task into an advisory revenue stream. Teaching clients to understand cash flow and applying repeatable frameworks increases client value and retention.

Educational programs that combine technical training with client execution frameworks make it easier to scale advisory services. For example, tools and training from Cash Flow Mike, including the *Clear Path To Cash* system, provide step-by-step techniques to find hidden cash, improve forecasting, and communicate effectively with clients.

Build a Repeatable Process

Successful advisors employ a consistent five-step approach: train, build, sell, execute, and grow. This progression helps turn a one-off cash flow statement into an ongoing advisory engagement that delivers measurable results for clients.

Programs like *Pathfinder* are specifically designed to help accountants and bookkeepers build, price, and execute advisory offerings. They include training, templates, scripts, and coaching to take advisors from uncertain to confident in their cash flow advisory services.

Leveraging Tools and Certification

Using software and structured training accelerates adoption and improves outcomes. The right tools automate calculations, track completeness of training, and help present findings to clients in a compelling way.

Apps, Resources, and Certification

Specialized apps and white-labeled resources help advisors scale. Certifications, such as those tied to the *Clear Path To Cash* program, lend credibility and can offer Continuing Professional Education (CPE) credits, a selling point for busy professionals.

For instance, the *Clear Path To Cash* certification offers a blended learning experience and up to 27 CPE credits, combining video lessons with live coaching. That kind of structured learning helps advisors master financial statement analysis, forecasting, and client conversations to drive action.

Delivering the Conversation That Drives Client Action

Generating insights is only half the battle. Advisors must present findings in a way that motivates clients to act. Effective client conversations start with clear, prioritized recommendations tied to cash outcomes.

Use an Action-Based Framework

Advisors can follow a framework like F.I.X. (Find, Identify, Execute) to lead the client from discovery to implementation. Start by identifying the burning cash issue, diagnose root causes, and propose a short list of high-impact actions with timelines and expected cash benefits.

Training programs that include client conversation coaching and templates make these meetings more efficient and more likely to result in client follow-through.

Next Steps for Advisors

Accountants and bookkeepers interested in adding cash flow advisory services should start by mastering the cash flow statement and the indirect method, then layer in forecasting, scenario planning, and client coaching skills. Joining a peer community and accessing ready-made tools accelerates the path to recurring revenue.

Organizations like Cash Flow Mike provide an integrated approach: courses, community, software, and certification that help advisors implement advisory programs without adding disproportionate billable hours. Programs such as *Pathfinder* and *Clear Path To Cash* supply worksheets, spreadsheets, coaching, and a structured 90-day execution plan to get services up and running with clients.

Checklist: Preparing a Cash Flow Statement (Indirect Method)

Use this checklist when preparing a cash flow statement to ensure completeness and accuracy.

• Gather income statements and comparative balance sheets for the current and prior periods.
• Start with net income.
• Add back non-cash charges (depreciation, amortization, stock comp).
• Adjust for gains/losses that are investing/financing related.
• Calculate changes in working capital using beginning and ending balances.
• Identify cash flows from investing activities (asset purchases and sales).
• Identify cash flows from financing activities (debt, equity, dividends).
• Reconcile the net change in cash to the balance sheet.
• Prepare supporting schedules and notes for significant items.

Build Revenue Through Cash Flow Advisory

The indirect method of preparing a cash flow statement links profit to cash in a way that is both practical and revealing. For advisors, mastering this method opens the door to deeper client conversations and meaningful advisory services that improve liquidity, support financing, and increase business value.

For firms seeking to offer structured, repeatable cash flow advisory services, investing in training, tools, and a proven process pays dividends. Resources like the *Clear Path To Cash* curriculum and the *Pathfinder* program give advisors the frameworks, templates, and coaching needed to convert cash flow expertise into recurring revenue and measurable client results.

Explore practical training and advisor-focused tools at Cash Flow Mike to learn how to implement cash flow advisory services and begin delivering this high-impact work to clients.

Turn Cash Flow Understanding into Ongoing Client Value

If you found this guide on preparing a cash flow statement using the indirect method useful, Cash Flow Mike can help you turn that knowledge into a recurring advisory service. We specialize in cash flow management training for accountants, bookkeepers, fractional CFOs, and SMEs, helping you uncover hidden cash, build reliable forecasts, and deliver high-impact recommendations without adding excessive hours. Choose the Basic, Standard, or Professional membership to get the Clear Path To Cash App, weekly group meetings, structured courses, certification opportunities, and personalized coaching tailored to your goals. Get Started Today!

Mike Milan

**Cash Flow Mike** Helping advisors and business owners find hidden cash, grow profits, and master cash flow. Creator of the Clear Path to Cash. ????

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