Question

While examining a company's cash flow statement, you notice that the section "cash flows from operating activities" includes items like "cash collected from customer" and "cash paid to suppliers." From this info, you can conclude that the company used which specific method of preparing the cash flow statement?
A direct method
B indirect method
C direct/indirect method hybrid
D A conclusion as to the method used cannot be drawn based on the info provided

Answer 1

Answer)

The correct answer in the given question is Option (A) Direct method.

Justifications:

(A) Direct Method: This option is correct

Under direct method, cash flow from operating activities is calculate by directly using cash flows (inflows and outflows) that are related to operating activities (i.e. core business activities) of a company. Thus, the format of cash flow includes items like Cash collected from customers, Cash paid to suppliers for purchase of merchandise, cash paid for operating expense, cash paid for income tax, etc. The resultant figure is the Net cash provided by (or used by) operating activities.

(B) Indirect Method: This option is Incorrect.

Under Indirect method, Net cash provided by (or used) by operating activities is calculated by starting from Net profit after tax and then adjustments is made for non-cash items like depreciation, amortization, items relating to financing activities (like payment of dividend), items relating to operating activities (like profit or loss on sale of assets) and changes in working capital (i.e. changes in balance of current assets and current liabilities in comparison to previous reporting period).

Thus, items like cash collected from customers and cash paid to suppliers is not entered in cash flow from operating activities under Indirect Method.

(C) Direct Indirect Method Hybrid: This option is incorrect as there is no hybrid method of cash flow statement

(D) Option (d) is also incorrect as from the given information conclusion can be drawn that such activities relate to cash flow from operating activities using Direct Method.