Indirect Cash Flow: What It Is, How It Works, and When to Use It

Cash flow is one of the most important tools for monitoring a company's financial health. It shows whether the business is truly generating enough resources to sustain its operations, pay off debts, and invest in growth. Among the methods available for this analysis, indirect cash flow is one of the most used in accounting and strategic reports.

Unlike the direct method, which lists all financial inflows and outflows, the indirect method starts with net income and makes adjustments to arrive at the effective cash. This format is required in financial statements and widely adopted by companies that need to be accountable to investors, banks, and auditors.

In this article, you will understand how indirect cash flow works, what its advantages and limitations are, and in which situations it should be applied to support financial management.

What is Indirect Cash Flow

Indirect cash flow is a way to demonstrate how the company's accounting result translates into cash generation (or consumption) over a specific period. Instead of listing all financial inflows and outflows, it starts with the net income reported in the income statement and makes adjustments to arrive at the actual value of available cash.

In practice, this method considers three major movements:

• Adjustments for accounting items that do not affect cash, such as depreciation, amortization, or provisions.
• Reversal of revenues and expenses that have not yet generated a financial impact, such as sales on credit or expenses payable.
• Variations in working capital, such as increases or decreases in inventory, accounts receivable, and accounts payable.

For this reason, indirect cash flow is widely used in formal financial reports, such as the Statement of Cash Flows (SCF), as required by accounting standards. It helps answer a central question for managers and investors: how much of the profit actually turned into cash?

Indirect cash flow is a method that connects the accounting result to the company's effective cash, allowing a clear view of the capacity to generate resources.

How the Indirect Method Works in Practice

The indirect method starts with the net income for the period, as reported in the Income Statement (IS), and makes adjustments until it arrives at the cash effectively generated or consumed. The reasoning is reconciliation: transforming the accounting result into financial flow.

Step-by-Step Calculation

1. Net income for the period

This is the starting point. It represents the result after deducting all expenses and taxes.

2. Adjustments for items that do not affect cash

• Depreciation and amortization.

• Provisions (e.g., labor contingencies).

• Unrealized exchange rate variations.

    These values reduce accounting profit but do not represent an outflow of money. Therefore, they are added back.
    
  

3. Adjustments for revenues and expenses that have not yet turned into cash

• Sales on credit (increase profit, but the cash has not yet come in).

• Expenses payable (have already reduced profit, but have not yet left the cash).

    These adjustments ensure that only movements with financial impact remain in the statement.
    
  

4. Variations in working capital

• Accounts receivable: an increase reduces cash; a decrease releases resources.
• Inventory: an increase represents the use of cash; a decrease means release.
• Accounts payable: an increase preserves cash; a decrease consumes cash.

5. Final result

After all adjustments, we arrive at the cash flow from operating activities, that is, how much the company's operation actually generated or consumed in terms of money in the period.

Simplified Example

Imagine a company that presented:

• Net income: R$ 200,000
• Depreciation: R$ 30,000
• Increase in accounts receivable: R$ 50,000
• Decrease in inventory: R$ 20,000

Calculation:

200,000 + 30,000 – 50,000 + 20,000 = R$ 200,000 of operating cash.

This example shows how indirect cash flow transforms the accounting result into a real cash value, showing whether the operation is in fact sustaining the company's liquidity.

How the Indirect Method Works in Practice

The indirect method starts with the net income for the period, as reported in the Income Statement (IS), and makes adjustments until it arrives at the cash effectively generated or consumed. The reasoning is reconciliation: transforming the accounting result into financial flow.

Step-by-Step Calculation

In practice, the calculation follows a logical sequence of adjustments:

1. Net income for the period

This is the starting point. It represents the result after deducting all expenses and taxes.

2. Adjustments for items that do not affect cash

Some entries reduce accounting profit but do not represent an outflow of money. They need to be added back, such as depreciation, amortization, provisions, and unrealized exchange rate variations.

3. Adjustments for revenues and expenses that have not yet turned into cash

At this point, revenues that increased profit but have not yet generated cash (such as sales on credit) and expenses that have already reduced profit but have not yet left the cash (such as accounts payable) come in.

4. Variations in working capital

Changes in accounts receivable, inventory, and accounts payable directly affect the cash position. An increase in accounts receivable, for example, reduces available cash. A reduction in inventory releases resources.

5. Final result

After all adjustments, we arrive at the cash flow from operating activities, which shows how much the company's operation actually generated or consumed in terms of money in the period.

Simplified Example

To visualize, imagine a company that presented the following numbers:

• Net income: R$ 200,000
• Depreciation: R$ 30,000
• Increase in accounts receivable: R$ 50,000
• Decrease in inventory: R$ 20,000

Applying the adjustments:

200,000 + 30,000 – 50,000 + 20,000 = R$ 200,000 of operating cash.

This example shows how indirect cash flow transforms the accounting result into a real cash value, showing whether the operation is in fact sustaining the company's liquidity.

Difference Between Direct and Indirect Cash Flow

There are two main methods for preparing the Statement of Cash Flows: the direct and the indirect. Although both aim to show how the company generated or consumed cash in a given period, they follow different presentation logics.

Comparing the Methods

The direct cash flow shows in detail all financial inflows and outflows, line by line. The indirect starts with the accounting net income and adjusts the information until it arrives at the cash value.

Direct Method	Indirect Method
Lists all cash inflows and outflows explicitly.	Starts with net income and makes accounting and working capital adjustments.
It is more intuitive for operational managers.	It is more used in accounting reports and legal requirements.
Facilitates daily cash control.	Connects the accounting result with the real cash generation.
Requires greater detail and data collection.	It is simpler to prepare, as it uses data already available in accounting.

When to Use Each One

The direct method is usually more useful for operational management, as it clearly shows where the money came from and where it went. The indirect method is widely adopted for formal financial reports, especially when the goal is to demonstrate to investors or auditors the relationship between accounting profit and cash generation.

Direct cash flow helps to see the day-to-day, while the indirect is a strategic tool for financial analysis and communication.

What are the Main Advantages of Indirect Cash Flow

The indirect method is the most adopted by medium and large companies worldwide, mainly because its preparation is simpler and aligned with accounting requirements. In addition, it brings relevant benefits for CFOs and financial managers.

Among the main advantages are:

• Ease of preparation: uses data already available in accounting, such as net income, depreciation, and provisions.
• Compliance with accounting standards: it is the method required in formal financial statements in Brazil (CPC 03) and in international standards (IFRS).
• Connection between profit and cash: clearly shows how much of the accounting result has actually turned into available money.
• Strategic analysis: allows assessing whether the company's operation is generating enough cash to sustain investments and debts.
• Acceptance by investors and banks: facilitates reading in financial reports and audits.

In practice, the indirect method translates the accounting language into cash information, becoming essential for high-level reports.

What are the Limitations of the Indirect Method

Despite its advantages, indirect cash flow also has limitations that need to be considered. It does not replace the operational control of cash, as it does not detail each inflow and outflow of resources.

The main restrictions of this method include:

• Less transparency in the day-to-day: does not clearly show which customers paid, which suppliers received, or the details of expenses paid.
• Less intuitive for non-accountants: managers without accounting training may have difficulty interpreting depreciation adjustments, provisions, or working capital.
• Dependence on accounting: as part of net income, the method depends on updated and correct accounting records.
• Little usefulness for short-term management: it is not the best tool to control daily balances or predict immediate cash needs.

Indirect cash flow is excellent for strategic reports and accounting compliance but should be complemented by more detailed controls (such as the direct method or financial management systems) to support operational decision-making.

When is it Worth Using Indirect Cash Flow

Indirect cash flow is not the ideal tool for monitoring cash on a day-to-day basis, but it is extremely valuable in certain strategic and accounting contexts. It gains relevance mainly when the company needs to present consolidated financial information to internal and external stakeholders.

The most common situations in which it is worth using the indirect method are:

• Mandatory accounting reports

The Statement of Cash Flows (SCF) required by accounting legislation must be prepared by the indirect method, according to CPC 03 in Brazil and international standards (IFRS).

• Presentations to banks and investors

Financial institutions and investment funds prefer this format because it connects accounting profit to real cash generation, allowing to assess the capacity to pay and generate value.

• External audits

The indirect method is recognized as a market standard, which facilitates reviews and independent audits.

• Medium and long-term strategic analyses

When the goal is to assess the financial sustainability of the business, this method shows whether the operation generates enough cash to support investments, expansion, or debt amortization.

Indirect cash flow is indispensable in formal reports and strategic analyses, but it should be complemented by more detailed controls when the company needs to monitor cash in real time.

Conclusion

Indirect cash flow is an essential tool for translating the accounting result into real cash generation. It facilitates strategic analysis, meets legal requirements, and provides a clear view for investors, banks, and audits.

Although it does not replace more detailed operational controls, its use is indispensable for companies seeking financial transparency and solidity in decision-making.

Ultimately, the indirect method helps CFOs and managers answer a central question: how much of the profit has actually turned into available money in the company's cash?