Teaching Operating Cash Flow : One Matrix for Analysis – Two Methods for Presentation

The operating activities section of the statement of cash flows presents a long-standing teaching challenge for accounting educators. The direct method is easy to understand yet difficult to prepare; the indirect method is harder to understand but easier to prepare. Many instructors address the two methods separately, requiring students to learn two different ways for preparing the operating section of a statement of cash flows. Because of this focus on the mechanics of preparation, the result is often an emphasis on how to prepare the cash flow statement rather than on the essential information the statement provides. In this paper, we note that both the direct and indirect methods begin at the same point, the income statement, and end at the same point, cash flow from operations. We then describe one process by which the income statement and the balance sheet can be analyzed so as to provide the information required to present operating cash flow using either the direct or the indirect method. Using this approach allows students to apply one intuitive process for computing cash flow from operations rather than memorizing two different sets of rules for the direct and indirect methods. This intuitive process makes the indirect method adjustments easier to understand and reduces the emphasis on rote mechanics