How does the indirect method work?
- Start from operating profit. From 2027, IFRS 18 requires the indirect method to start from operating profit. Before that, IAS 7 allowed profit or loss, and many companies start from profit before tax.
- Add back non-cash expenses such as depreciation, amortisation and impairment, and deduct non-cash income.
- Remove gains and losses that belong elsewhere, such as a gain on selling equipment, whose proceeds are investing cash flows.
- Adjust for working capital: changes in receivables, inventories and payables.
- Deduct income taxes paid, which are operating cash flows unless specifically identified with investing or financing.
A worked indirect method example
| CU million | Amount |
|---|---|
| Operating profit | 222 |
| Depreciation and amortisation | 190 |
| Impairment losses | 12 |
| Gain on disposal of equipment (proceeds are investing) | (10) |
| Change in working capital (below) | (15) |
| Income taxes paid | (45) |
| Net cash from operating activities | 354 |
How are working capital changes calculated?
| CU million | Opening | Closing | Cash effect |
|---|---|---|---|
| Trade receivables (asset rose: cash not yet collected) | 180 | 200 | (20) |
| Inventories (asset fell: stock turned into cash) | 120 | 115 | 5 |
| Trade payables (liability rose: cash not yet paid) | 150 | 152 | 2 |
| Accruals (liability fell: cash paid out) | 40 | 38 | (2) |
| Change in working capital | (15) |
The rule: an increase in an asset uses cash, a decrease releases it; an increase in a liability keeps cash, a decrease uses it. Exclude balances that relate to investing or financing, such as payables for capital expenditure or accrued interest, and adjust for balances acquired in business combinations, which are investing.
How does it compare with the direct method?
| Direct method, CU million | Amount |
|---|---|
| Cash received from customers | 1,480 |
| Cash paid to suppliers and employees | (1,081) |
| Income taxes paid | (45) |
| Net cash from operating activities | 354 |
Both methods give the same total. The direct method shows where the cash came from and went, which IAS 7 encourages; the indirect method shows why profit and cash differ. US GAAP requires a reconciliation of net income to operating cash flow even when the direct method is used; IAS 7 does not.
Common indirect method mistakes
- Getting the working capital signs the wrong way round.
- Including the change in payables for capital expenditure, which should adjust the investing outflow instead.
- Adding back the tax expense and also deducting tax paid, double counting.
- Leaving gains on disposal in operating cash flow while also showing the full proceeds in investing.
How does it work before IFRS 18?
Until 2027, many companies start from profit before tax. They then add back finance costs and deduct investment income, because those are not operating items, and show interest paid and received either in operating activities or in financing and investing, depending on their policy. If interest paid is classified as operating, it is deducted after the working capital changes, alongside income taxes paid.
What changes under IFRS 18?
The starting point becomes operating profit for everyone, and interest and dividends move out of operating activities for most companies, so operating cash flow will rise for companies that classified interest paid as operating. See the IFRS 18 cash flow changes.
Can you build it in Excel?
Yes. The Cash flow statement template (Excel) now includes a working capital sheet that derives the change from opening and closing balances and feeds it into an indirect-method statement starting from operating profit. See also IAS 7 explained.
Need help applying the standards?
Our Chartered Accountants help finance teams and students apply IFRS and US GAAP to real transactions.
Questions people ask
What is the indirect method?
A way of presenting operating cash flows that starts from profit, or operating profit under IFRS 18, and adjusts for non-cash items, working capital changes and income taxes paid.
Why is depreciation added back in the indirect method?
Because it reduces profit without any cash outflow; the cash was spent when the asset was bought, in investing activities.
How do changes in receivables affect operating cash flow?
An increase in receivables reduces operating cash flow, because sales have been recognised but cash not yet collected.
What does the indirect method start from under IFRS 18?
Operating profit, the new IFRS 18 subtotal.
Sources
Every fee, date and rule on this page was taken from these official and primary sources.
Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.
Related guides
More in IAS 7
This guide is general information. It is not tax or legal advice for your situation.