Direct vs Indirect Cash Flow Methods

Direct vs Indirect Cash Flow Differences

Companies prepare the income statement using both expenses and revenues. direct vs indirect cash flow method want to look at their overall performance over a period of time.  Likewise, cash flow statement is another financial statement that every investor should look at.

The cash flow statement contains three sets of activities namely operating, investing and financing. Usually, the investing and financing sections are calculated in a similar manner.

But when it comes to calculating cash flow from operational activity, two methods of calculation are majorly used – indirect method and direct method.

• The indirect method of cash flow uses net income as the base and does 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 activities 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 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. 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

Basis for comparison between Direct vs Indirect Cash Flows	Cash flow indirect method	Cash flow direct method
Definition	Indirect method uses net income as a base and adds non-cash expenses like depreciation, deducts non-cash incomes like profit on sale of scraps and net adjustments between current assets & liabilities to produce the overall cash flow statement.	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 taken	All the factors are taken into account.	All non-cash transactions like depreciation are ignored.
Preparations	Preparations are mainly needed during conversion of net income into cash flow statement.	There’s no such preparation required.
Accuracy	Cash flow statement under indirect method is not very accurate as adjustments are being made.	Cash flow statement under 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	This method is predominantly used by many companies.	Compared to 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.

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