Likewise, decreases in the current liabilities are recorded as decreases in the company’s cash inflows. In addition, the indirect method begins with the income statement’s net income data. Further, noncash deductions are added back to the net income to arrive at the correct cash inflow (Stickney, 2009).
For example, the income statement shows a deduction for depreciation expense. Since the indirect methods starts with the net income, the depreciation expense reduced the company’s net income amount. Consequently, the proper process is to add back the depreciation expense to the net income. The reason is very obvious. All company expenses have a correspondent credit to cash or cash equivalents. However, there was no cash outflow or payment made when the company debited depreciation expense. To arrive at the amount of cash that flowed into the company’s coffers, the next step is to add back the cash-absent depreciation expense. The same process is applied to the amortization expense. Amortization expense is debited but there is no corresponding credit to cash or cash equivalents. ...Show more