There are two ways the cash flow statement can be prepared: the direct method, and the indirect method.
The direct method is the easiest to understand, but rarely used in more publicly traded companies. We just record all the cash inflows and outflows as they happen, categorizing them between cash flow from operations, cash flow from investments, and cash flow from financing. For example, cash flow from operations may include cash flows from customers, cash paid to employees, etc. The indirect method is much more common with publicly traded companies, since it provides a reconciliation from net income to cash. By using net income as a starting point to calculate cash flow, the reader is able to appreciate the relationship between net income and cash flow, and all the items in between.
In the indirect method, we start with net income and add back all the non-cash items in the income statement as well as net working capital. Afterwards, any other cash flow numbers not included in the income statement are also added in.
Below are the three sections of the cash flow statement; this is not necessary for your verbal answer, but they’re displayed here for clarity.
Cash flow from operations: starting from net income, we then account for changes in net working capital, and we also add all non-cash items in the income statement such as depreciation and amortization
Cash flow from investing: includes any cash outflow which results in the purchase of an asset, such as capital expenditures (capex) and business acquisitions
Cash flow from financing: includes any cash flows raised from issuance of debt or equity, as well as any debt repayments or dividends