Statement of Cash Flows Under US GAAP: Direct vs Indirect Method
By SimplyCPA · 11 October 2026
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- Three sections: Operating (day-to-day business), investing (long-term assets and investments) and financing (debt and equity with owners and lenders).
- Interest and dividends (US GAAP): Interest paid, interest received and dividends received are operating. Dividends paid are financing.
- Direct method: Lists the main classes of cash receipts and payments. If used, a reconciliation of net income to operating cash flow must also be disclosed.
- Indirect method: Starts from net income and adjusts for non-cash items, gains and losses, and changes in working capital.
- Investing and financing: Identical under both methods; only the operating section differs. Significant non-cash transactions are disclosed separately.
The three categories (ASC 230)
| Section | Typical inflows | Typical outflows |
|---|---|---|
| Operating | Cash from customers, interest received, dividends received | Payments to suppliers and employees, interest paid, income taxes paid |
| Investing | Sale of property, plant and equipment; sale of investments; collection of loans made | Purchase of PP&E and investments; loans made to others |
| Financing | Issuing shares or bonds; borrowing | Repaying principal; buying back shares; dividends paid; debt prepayment or extinguishment costs |
Cash includes cash equivalents and, since ASU 2016-18, restricted cash. Transfers between restricted and unrestricted cash are not cash flows.
Exam trap: Under US GAAP, interest paid is operating, not financing — even though the loan principal is financing. Under IFRS it's currently a policy choice.
Worked example
For Year 2, a company reports net income of $120,000, which includes depreciation of $30,000 and a $5,000 gain on the sale of equipment (sold for $25,000). Working capital changes: accounts receivable up $15,000; inventory down $8,000; accounts payable up $6,000; accrued wages down $2,000. Sales were $900,000 and cost of goods sold $540,000.
Indirect method
| Net income | $120,000 |
| + Depreciation | 30,000 |
| − Gain on sale of equipment | (5,000) |
| − Increase in accounts receivable | (15,000) |
| + Decrease in inventory | 8,000 |
| + Increase in accounts payable | 6,000 |
| − Decrease in accrued wages | (2,000) |
| Net cash from operating activities | $142,000 |
The $25,000 proceeds from the equipment sale go in investing — which is why the gain is removed from operating.
Direct method (extract)
- Cash from customers = Sales − increase in receivables = $900,000 − $15,000 = $885,000
- Cash paid to suppliers = COGS − decrease in inventory − increase in payables = $540,000 − $8,000 − $6,000 = $526,000
The remaining operating lines (wages, other expenses, interest, taxes) are calculated the same way, and the total always equals the indirect-method figure.
Memory rule for working capital
- Current asset increases are subtracted; decreases are added.
- Current liability increases are added; decreases are subtracted.
Specific classification rules (ASU 2016-15)
- Debt prepayment or extinguishment costs — financing.
- Contingent consideration paid soon after a business combination — investing; later payments split between financing and operating.
- Insurance settlement proceeds — classified by the nature of the loss.
- Distributions from equity-method investees — a policy choice between the cumulative-earnings approach and the nature-of-distribution approach.
Non-cash investing and financing
Transactions such as acquiring a building by issuing a mortgage, converting bonds to shares, or recognising a right-of-use asset for a new lease are disclosed separately, not shown in the statement's three sections.
Practise further in our FAR statement of cash flows notes.