Direct and Indirect Methods of Cash Flow

In accounting, a statement of cash flows shows the history of the company’s ingoing and outgoing money operations during a definite time period. This statement shows how changes in accounts and a company’s balance affect cash equivalents, which is essential to determine a company’s creditability.

There are two different ways to create a cash flows statement. A direct cash flow statement starts with cash operating activities: sale of goods and services, cash received from customers, and cash payments to operating expenses, taxes and interests paid. Then cash flows from investing activities are calculated: received dividends and proceeds from the sale of equipment. After cash flows from investing activities are calculated, cash flows from financing activities should be calculated, which are usually limited to dividends paid.

The presentation of indirect and direct cash flow methods is different.

Presentation of direct method:

Cash at beginning	xx
Add: cash received from customers	xx
Add: interest received	xx
Less: cash paid to suppliers	xx
Less: cash payments of salaries		xx
Less: interest paid	xx
Add (less) : other adjustments		xx
Add(less): cash from investing activities		xx
Add (less) cash from operations		xx
Cash at the end of the year	xx

Presentation of indirect method:

Cash at beginning	xx
Net income	xx
Add: non-cash items	xx
Add: increase in payables	xx
Less: increase in receivables	xx
Add(less): other adjustments	xx
Add(less): cash from investing activities		xx
Add(less): cash from financing activities		xx
Cash at the end of the year	xx

Accountants mainly use the indirect method for a number of reasons. The main reason is that this method considers the operating profit of the company which is not very tedious to calculate since most of the figures are available. The indirect method is tedious considering it will take a number of days to sustain the actual amount paid to customers or received from customers.