In the indirect method, because the focus is on accrual accounting, we start with the net income of the company taken from the income statement, adjust for any non-cash related transactions (for example: amortization) and adjust for the movement in assets or liabilities between the current financial period to the prior financial period. In the direct method, as we have explained, the focus is to identify the actual operating cash receipts and cash payments during a financial period. The main difference between the direct method and the indirect method is that the former uses the cash accounting basis and the latter uses the accrual accounting basis. Difference Between the Direct Method and the Indirect Method Take this as a very literal approach to listing the actual cash that went in and out of the company for any transactions that are directly related to the core operations.Īs you can imagine, the direct method gives a clearer view of the cash receipts and payments of a company but it is far more time-consuming to identify these transactions than using the indirect method. In the direct method, just like the name suggests, you simply take all the cash inflows and outflows related to the operations of the company and sum them up to arrive at the total cash flows from operating activities.Īs such, you will list the income and sales of the company (inflows) and subtract the expenses (outflows). The section that will differ between the direct method and the indirect method is the operating activities. The investing and financing activities sections will stay the same whether it’s the direct or indirect method. A company can choose the direct method or the indirect method. There are two ways to prepare the cash flow statements. The Direct Method: ExplainedĪ cash flow statement contains three sections the operating activities, investing activities and financing activities. We will take a deeper look into the direct method and illustrate it with an example. In the accounting world, there are two ways to draft the cash flow statement the direct method and the indirect method. It shows inflows and outflows of money for a specified financial period.Īlong with the balance sheet and income statement, the cash flow statement is considered an important section of a set of financial statements. The cash flow statement gives a great insight into a company’s cash management.
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