Direct and indirect are the two different methods used for the preparation of the cash flow statement of the companies with the main difference relates to the cash flows from the operating activities where in case of direct cash flow method changes in the cash receipts and the cash payments are reported in cash flows from the operating activities section whereas in case of indirect cash flow method changes in assets and liabilities accounts is adjusted in the net income to arrive cash flows from the operating activities.
Direct vs. Indirect Cash Flow Differences
The cash flow statement contains three sets of activities, namely operating, investing, and financing. Usually, the investing and financing sections are calculated similarly.
But when it comes to calculating cash flow from operational activityCash Flow From Operational ActivityCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital., two methods of calculation are majorly used – indirect method and direct method.
- The indirect method of cash flow uses net income as the base. It makes the adjustments needed, i.e., adding and subtracting the variables to convert the total net income to cash amount from operations.
- The direct method of cash flow in operating activitiesOperating ActivitiesOperating activities generate the majority of the company's cash flows since they are directly linked to the company's core business activities such as sales, distribution, and production. includes the cash being received from the customers and the cash paid to the suppliers, employees, and others. The cash can also be paid for income tax, interest, and other variables.
- The direct method of cash flow starts with cash transactions such as cash received and cash paid while ignoring the non-cash transactions.
- Indirect cash flow method, on the other hand, the calculation starts from the net income, and then we go along adjusting the rest.
Direct and Indirect Cash Flow Methods Infographics
Here are the top 7 difference between Direct and Indirect Cash Flow Methods
Direct Cash Flow vs. Indirect Cash Flow Method Key Differences
Here are the key differences between direct vs. indirect cash flow methods–
- One of the key differences between direct cash flow vs. indirect cash flow method is the type of transactions used to produce a cash flow statement. The indirect method uses net income as the base and converts the income into the cash flow through the use of adjustments. The direct method only takes the cash transactions into account and produces the cash flow from operations.
- The cash flow indirect method makes sure to convert the net income in terms of cash flow automatically. The cash flow direct method, on the other hand, records the cash transactions separately and then produces the cash flow statement.
- The cash flow indirect method needs preparation as the adjustments that are made to require time. The preparation time for the cash flow direct method isn’t much since it only uses cash transactions.
- The accuracy of the cash flow indirect method is a little less as it uses adjustments. Comparatively, the cash flow direct method is more accurate as adjustments are not used here.
So, what are the differences between direct and indirect cash flow methods? Let’s have a look at the head to head differences between the direct and indirect cash flow methods.
Direct vs. Indirect Cash Flow Method Head to Head Differences
Here are the basic differences between direct vs. indirect cash flow methods
|The basis for comparison between Direct vs. Indirect Cash Flows||Cash flow indirect method||Cash flow direct method|
|Definition||The indirect method uses net income as a base and adds non-cash expensesNon-cash ExpensesNon-cash expenses are those expenses recorded in the firm's income statement for the period under consideration; such costs are not paid or dealt with in cash by the firm. It involves expenses such as depreciation. like depreciation, deducts non-cash incomes like profit on the sale of scraps, and net adjustments between current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. & liabilities to produce the overall cash flow statement.||The direct method uses only the cash transactions, i.e., cash spent and cash received to produce the cash flow statement.|
|Working||Net income is automatically converted in the form of cash flow.||Reconciliation is done to separate the cash flow from others.|
|Factors are taken||All the factors are taken into account.||All non-cash transactions like depreciation are ignored.|
|Preparations||Preparations are mainly needed during the conversion of net income into cash flow statement.||There’s no such preparation required.|
|Accuracy||The cash flow statement under the indirect method is not very accurate as adjustments are being made.||The Cash flow statementCash Flow StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities. under the direct method is very accurate as there is no need for any adjustments here.|
|Time taken||It takes less amount of time compared to the direct method.||It takes more amount of time compared to the indirect method.|
|Popularity||Many companies predominantly use this method.||Compared to the indirect method, they are only a very few companies that use this method.|
Direct vs. Indirect Cash Flow Method – Conclusion
Both the direct vs. indirect cash flow method is useful at different points, and they can be used depending on the situation and the requirement. The indirect method is the most popular among companies. But it takes a lot of time to prepare (before recording), and it’s not very accurate as many adjustments are used.
The direct method, on the other hand, doesn’t need any preparation time other than segregating the cash transactions from the non-cash transactions. And it’s more accurate than the indirect method.
Direct vs. Indirect Cash Flow Methods Video
This article has been a guide to the top differences between direct and indirect cash flow methods. Here we also discuss the direct vs. indirect cash flow method key differences with infographics and comparison table. You may also have a look at the following articles –