The indirect method

Learning objectives

• Explain the logic of the indirect method (wording before IFRS 18): from profit or loss to net cash flow from operating activities.L1, L2
• Calculate net cash flow from operating activities: non-cash items, items relating to investing or financing, changes in working capital.L2, L3, L4
• Analyse an incorrect reconciliation (sign of a change, gain on disposal, provision, share of profit of an associate) and correct it.L2, L3, L4
• Calculate net cash flow from operating activities from operating profit or loss under the version applicable from 1 January 2027 (IAS 7 as amended by IFRS 18).L2, L3

Normative references

• IAS 7 §18Operating cash flows are reported under one of two methods: the direct method, which shows the main classes of gross receipts and gross payments, or the indirect method, which starts from profit or loss and corrects it for non-cash transactions, for deferrals and accruals of past or future operating receipts and payments, and for income and expense items whose cash effects relate to investing or financing (wording before IFRS 18).
• IAS 7 §20Under the indirect method, net operating cash flow is obtained by correcting profit or loss for three groups of items: movements in the period in inventories and in operating receivables and payables; items with no cash effect (for example depreciation, provisions, deferred tax, unrealised exchange gains and losses, and associates' undistributed profits); and any other item whose cash effect falls within investing or financing. As a variant, the indirect method may display the revenue and expenses shown in the statement of comprehensive income, followed by the movements in inventories and operating receivables and payables (wording before IFRS 18).
• IAS 7 §64The amendments to IAS 7 made by IFRS 18 (April 2024) — paras. 6, 10, 12, 14, 16 to 18, 20, 31, 32, 35, 46 and 47 amended, paras. 33A and 34A to 34D added, paras. 33 and 34 deleted — apply when the entity applies IFRS 18; IAS 7 sets no date of its own.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

22 questions

• Under the indirect method, net operating cash flow is determined by adjusting profit or loss for non-cash transactions, deferrals or accruals of operating receipts or payments, and items associated with investing or financing.L1
• Under the indirect method, the undistributed share of profit of an associate is a non-cash item to remove from profit.L2
• What is the starting point of the indirect method (wording applicable before 2027)?L1
• How is a net provision charge treated under the indirect method?L2
• Which alternative presentation of the indirect method does the standard allow?L2
• Which of these items are added back or deducted as non-cash items under the indirect method?L2
• In Torbris's indirect reconciliation, which adjustments are deducted from profit?L3
• Nalbris's profit: {profit}. Depreciation: {depreciation}. Trade receivables increase by {receivables_increase}, inventories decrease by {inventory_decrease} and trade payables increase by {payables_increase}. Compute net operating cash flow (indirect method).L2
• This year Ervelle reports profit of {profit} after {depreciation} of depreciation. Its customers paid faster (receivables down by {receivables_decrease}), but it built up stock (increase of {inventory_increase}) and paid some suppliers earlier (payables down by {payables_decrease}). What is its net operating cash flow under the indirect method?L2
• Torbane's profit: {profit}. It includes depreciation of {depreciation}, a net provision charge of {provision_charge} and a gain on disposal of a machine of {gain_on_disposal}. Working capital changes amount to a net outflow of {working_capital_outflow}. Compute net operating cash flow.L3
• Vervane's consolidated profit: {profit}, including a share of profit of an associate of {associate_share}; the associate paid {dividend_received} of dividends, classified as operating under the group's policy (case data). Other items: depreciation {depreciation}, deferred tax expense {deferred_tax}, unrealised exchange loss on a loan {unrealised_fx_loss}. Compute net operating cash flow (working capital assumed unchanged).L3
• Delvane's warranty provision moves from {opening_provision} to {closing_provision}; the charge for the year is {provision_charge} and uses (repairs paid) make up the rest of the movement. Profit is {profit}, depreciation {depreciation}; no other changes (case data). Compute the provision adjustment and net operating cash flow.L3
• Torvane starts from its profit before tax of {profit_before_tax} (presentation chosen by the entity, case data). It includes depreciation {depreciation}, loss on disposal {loss_on_disposal} and interest expense {interest_expense}; interest paid is classified as financing (entity policy). Inventories rise by {inventory_increase}, receivables fall by {receivables_decrease}, payables rise by {payables_increase}. Tax paid is {tax_paid}. Compute net operating cash flow.L4
• Sorlane's balance sheets: inventories {opening_inventory} then {closing_inventory}; trade receivables {opening_receivables} then {closing_receivables}; prepayments {opening_prepaid} then {closing_prepaid}; trade payables {opening_payables} then {closing_payables}. Profit {profit}, depreciation {depreciation}. Compute the net working capital effect (negative if an outflow) and net operating cash flow.L4
• In Halvora's reconciliation, the 80,000 increase in inventories is added to profit, “because inventories are an asset of the entity”. What is the error?L2
• Rosdane sold a warehouse at a gain of 120,000; its indirect reconciliation leaves this gain in profit, and the price of 640,000 also appears in investing. What is the error?L3
• In Belquine's statement, the 90,000 litigation provision charge is deducted from profit, “because it is an expense to be paid”. No payment occurred. What is the error?L3
• Quelbane recognises a share of profit of its joint venture of 250,000, of which 90,000 was paid to it as dividends. Its indirect reconciliation does not adjust the share and also presents the 90,000 as an investing inflow, in line with its method for classifying dividends received (case data). What is the error?L4
• Nervane's operating cash flow is 1.1 million while its profit is only 300,000. The analyst notes a sharp fall in receivables and a rise in trade payables. Which explanation is consistent with the indirect method?L3
• Ulvora's draft reconciliation: profit 500,000; + depreciation 140,000; + gain on disposal 35,000; − provision charge 25,000; − increase in receivables 60,000. What is the corrected operating cash flow?L3
• Ostmira, a holding company, reports profit of 2 million, of which 1.4 million is its share of associates, which paid it only 0.3 million in dividends (classified as operating under its policy, case data). Its published operating cash flow is 2.2 million before any other adjustment. What conclusion should be drawn?L4
• Case data: Pelvane, a manufacturer, applies IFRS 18 for its period beginning 1 January 2027. Operating profit 600,000; profit for the year 380,000; depreciation (operating category) 120,000; increase in trade receivables 50,000; income tax paid 110,000. No other items. What is net cash flow from operating activities (indirect method)?L3