Indirect method
In one sentenceA way of calculating operating cash flows that starts from net profit, then adds back non-cash items such as depreciation and adjusts for changes in working capital.
Simply put
It is the most widely used because it is built directly from the income statement and the financial position. You add back depreciation because it is an expense with no cash outflow, then adjust: increases in receivables and inventory are deducted because they tied up cash, and increases in amounts owed to suppliers are added because they deferred payment.
Its value is that it explains the difference between profit and cash item by item.
Worked example
A trading business has a net profit of 120,000 SAR and depreciation of 40,000 SAR. Its receivables rose by 30,000 SAR, its inventory by 20,000 SAR, and amounts owed to suppliers rose by 15,000 SAR.
Net profit + depreciation = 120,000 + 40,000160,000
− Increase in receivables(30,000)
− Increase in inventory(20,000)
+ Increase in payables15,000
Net operating cash flow = 160,000 − 30,000 − 20,000 + 15,000125,000 SAR
Formula: Net profit + non-cash items ± change in working capital
Don't confuse it with
Direct methodThe direct method lists receipts and payments, while the indirect method starts from profit and arrives at the same figure.