>> I'm glad you asked that question here because this is the best place for
me to show you why the direct method is not that useful for
the operating section of the cash flow statement.
Let me jump out to the slide to show you what I mean.
So Relic Spotters cash collected from customers was 156,300.
Is that good or bad?
Relic Spotter's cash paid to suppliers was 40,000.
Is that good or bad?
Well, you can't tell without some kind of benchmark.
You could look at prior year numbers to see if there's a trend, but
what we really want to know is what was the level of activity surrounding these
cash collections during the year?
For example, if Relic Spotter had 157,000 of revenue and
collected 156,300 in cash, then the cash flow makes sense.
But if Relic Spotter had 500,000 in revenue, but
only collected 156,300, then there may be a problem.
Or let's say that Relic Spotter sold 40,000 of inventory,
paid 40,000 to their suppliers.
Again, the cash flow makes sense, but
what if Relic Spotter only sold 10,000 of inventory?
Then the question is,
why did they spend an extra 30,000 in cash to acquire inventory they didn't sell?
What the indirect method's going to do is start with net income as a benchmark for
the expected level of activity or expected level of cash flows during the period, and
then highlight any discrepancies from that level.
This is the kind of thing we'll talk about when we do an analysis of an indirect cash
flow statement after we've finally put one together later in the video.