Definition of 'Direct Method'
The direct method starts with net income from the income statement. Then, it adds back non-cash expenses, such as depreciation and amortization, and subtracts non-cash revenues, such as gains on the sale of investments. The result is cash flow from operating activities.
The direct method is more intuitive than the indirect method because it shows the actual cash flows from operating activities. However, the direct method can be more difficult to calculate than the indirect method.
Here is an example of how the direct method works:
* Net income from the income statement is $100,000.
* Non-cash expenses, such as depreciation and amortization, are $20,000.
* Non-cash revenues, such as gains on the sale of investments, are $10,000.
* Cash flow from operating activities is $110,000.
The direct method is a useful tool for understanding a company's cash flow from operating activities. It can be used to compare companies with different accounting methods and to identify potential problems with a company's cash flow.
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