If your team hasn’t prepared a direct method cash flow statement in years but has 10+ years of experience using the indirect method, this is likely the better choice. Since the direct method simply utilizes all cash-based transactions to prepare the operating cash flow section, the calculations are simple, straightforward, and easy to follow. Here are some of the main benefits that you’ll find from using the direct method for cash flow statements. Understanding the differences between the two main methods for preparing the cash flow statement–the direct method and the indirect method–can sometimes be a challenge if you’re not a trained accountant. Listing out information this way provides the financial statement user with a more detailed view of where a company’s cash came from and how it was disbursed.

Further, the indirect method for building cash flow statements could provide a less accurate depiction of the business’s current cash positioning. In this example, no cash had been received but $500 in revenue had been recognized. The offset was sitting in the accounts receivable line item on the balance sheet.

What Is the Difference Between Direct and Indirect Cash Flow?

Contact the professionals at Accounting and Tax Advisers CPAs in Lombard, IL. Our team has the experience and knowledge to help with all your small business accounting, tax services, and financial consulting. Cash flow forecasting is a crucial element that can make or break any business, regardless of its size. At its simplest, cash flow forecasting is about monitoring the dollars that flow in and out of a business. Cash flow forecasting enables teams to strategically allocate resources to optimize their future.

However, if the organization uses the direct method, it is still recommended to reconcile the cash flow statement to the balance sheet. In contrast, there are no such changes in the direct method in the direct approach. The cash flow from operations is generally prepared by accounting for cash receipts and indirect cash flow vs direct payments in the direct method. Because most businesses utilize the accrual method of accounting, the data on the income statement and balance sheet will be consistent with this technique. In this article, we’ll go through what are direct and indirect cash flow methods and differences between the two.

Direct Method: Complexities of Cash Flow Method of Accounting

The benefit of the indirect method is that it lets you see why your net profit is different from your closing bank position. But because it’s based on adjustments, one of its disadvantages is that it doesn’t offer the same visibility into cash transactions or break down their sources. Unlike the direct method, the indirect method provides less detailed information about specific cash flow activities. It doesn’t offer a deep understanding of what contributes to the company’s net cash flows. Many accountants prefer the indirect method because it’s easier to prepare. It uses information from existing financial statements, saving time and effort compared to the direct method.

Because most businesses operate using the accrual method of accounting, the indirect method is more widely used. The indirect method is also much quicker than the direct method because it utilizes information readily available on the income statement and the balance sheet. Unlike the direct method, the indirect method uses net income as a baseline.

Benefits and Drawbacks of Indirect Cash Flow

For instance, assume that sales are stated at $100,000 on an accrual basis. If accounts receivable increased by $5,000, cash collections from customers would be $95,000, calculated as $100,000 – $5,000. The direct method also converts all remaining items on the income statement to a cash basis. It’s important to remember that the indirect method is based on information from your income statement, which could have certain limitations.

This method converts each item on the income statement directly to a cash basis. Alternatively, the indirect method starts with accrual basis net income and indirectly adjusts net income for items that affected reported net income but did not involve cash. The direct cash flow method, also known as the income statement method, focuses on presenting a business’s actual cash inflows and outflows. This method requires a detailed breakdown of cash receipts and payments from various activities, such as operating, investing, and financing.