Direct vs Indirect Cash Flow Methods

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 Activity Cash 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.read more, two methods of calculation are majorly used – indirect method and direct method.

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Source: Direct vs Indirect Cash Flow Methods (wallstreetmojo.com)

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 Activities Operating 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.read more 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

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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 Expenses Non-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.read more like depreciation, deducts non-cash incomes like profit on the sale of scraps, and net adjustments between current assetsCurrent Assets Current 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.read more & 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.	ReconciliationReconciliation Reconciliation is the process of comparing account balances to identify any financial inconsistencies, discrepancies, omissions, or even fraud. At the end of any accounting period, reconciliation involves matching balances and ensuring that debits (credits) from one account for one transaction is same as the credit (debits) to another account for the same transaction.read more is done to separate the cash flow from others.
Factors are taken	All the factors are taken into account.	All non-cash transactions like depreciationDepreciation Depreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more 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 Statement A Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more 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.