Direct vs Indirect Cash Flow Methods
Last Updated :
21 Aug, 2024
Blog Author :
Wallstreetmojo Team
Edited by :
Susmita Pathak
Reviewed by :
Dheeraj Vaidya
Table Of Contents
Direct and indirect are the two different methods used for the preparation of the cash flow statement of the companies, with the main difference relating to the cash flows from the operating activities. In contrast, in the case of the direct cash flow method, changes in the cash receipts and the cash payments are reported in cash flows from the operating activities section. In contrast, in the case of the indirect cash flow method, changes in assets and liabilities accounts are adjusted in the net income to arrive at cash flows from the operating activities.
Direct vs. Indirect Cash Flow Differences
The cash flow statement contains three 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 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. It makes the necessary adjustments, i.e., adding and subtracting the variables to convert the total net income to cash 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 cash flow method 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.
Table of contents
Direct and Indirect Cash Flow Methods Infographics
Here are the top 7 difference between Direct and Indirect Cash Flow Methods
Direct vs. Indirect Cash Flow Methods Explained in Video
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 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 automatically convert the net income in terms of cash flow. 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 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. 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? First, let’s 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 expenses like depreciation, deducts non-cash incomes like profit on the sale of scraps, and net adjustments between current assets & 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 statement 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
The direct vs. indirect cash flow method is useful at different points, and it 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.
On the other hand, the direct method 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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