# Indirect/Direct conversion

To convert an indirect statement of cash flows to a direct basis, the analyst would: A) subtract any depreciation that was included in the cost of goods sold. B) add decreases in inventory to the cost of goods sold. C) subtract decreases in accounts receivables from net sales. D) add decreases in accounts payable to the cost of goods sold Comments people…

depreciation is ignored in the direct method. So a is wrong. Change in Inventory is added to Sales. So B is wrong. Decrease in AR is ADDED to Net Sales. So C is wrong. Leaves D as the right answer.

Here is the weird explanation: Answer is A: Decreases in inventory represent a source of cash so these would be added to the negative cost of goods sold figure (i.e. make it less negative). Any depreciation and/or amortization included in the cost of goods sold does not represent an actual use of cash, so this amount should be added to the negative cost of goods sold figure (i.e. make it less negative). A decrease in accounts receivables represents an increase in cash so this should be added to the sales figure. Decreases in accounts payable represent a use of cash so these should be subtracted from the negative cost of goods sold figure (i.e. make it more negative).

I think the answer choice in this one is wrong. A) subtract any depreciation that was included in the cost of goods sold. B) add decreases in inventory to the cost of goods sold. C) subtract decreases in accounts receivables from net sales. D) add decreases in accounts payable to the cost of goods sold A is wrong. Given depreciation is Not used in the Direct Method. B is right. Decrease on Inventory would be add on to the negative COGS to make it less negative. Decrease on Inventory is a Source of cash. Decrease is AR is Added To Net Sales – Source of Cash. Decrease in AP is a Use of Cash. So it is subtracted from the COGS.

I am also for D…

I was always for B… Remember Net Sales + Change in AR. AR Increase ==> Change in AR is a decrease AR Decrease ==> Change in AR is an increase COGS + Change in AP + Change in Inv. Inventory is a CURRENT ASSET Inv Increase ==> Change in AR is a decrease Inv Decrease ==> Change in AR is an increase AP is a CURRENT Liability AP Increase ==> Change in AP is an Increase AP Decrease ==> Change in AP is a decrease Use this to remember your flows. Use the sign on the Increase or Decreased component, and then always ADD to the Net Sales or COGS figure. I also used the convention A ==> Net Sales + Change in AR B ==> COGS + Change in AP + Change in Inv. I am ignoring the Taxes, Interest here. *** Then CFO ==> A - B