Difference Between Direct and Indirect Cash Flow

Key Difference – Direct vs Indirect Cash Flow
 

Direct and indirect cash flow are two methods of arriving at the net cash flow from operating activities in the cash flow statement. Cash flow statement consist of three main sections: net cash flow from operating activities, net cash flow from investing activities and net cash flow from financing activities. The key difference between direct and indirect cash flow method is that direct cash flow method lists all the major operating cash receipts and payments for the accounting year by source whereas indirect cash flow method adjusts net income for the changes in balance sheet accounts to calculate the cash flow from operating activities. IASB (International Accounting Standards Board) gives the freedom for organizations to select the direct or indirect method to calculate net cash flow from operations.

CONTENTS
1. Overview and Key Difference
2. What is Direct Cash Flow
3. What is Indirect Cash Flow
4. Side by Side Comparison – Direct vs Indirect Cash Flow
5. Summary

What is Direct Cash Flow?

The direct cash flow method lists all the major operating cash receipts and payments for the accounting year by source. In other words, it lists how the cash inflows arose and how the cash outflows were paid.  After all sources are listed, the difference between cash inflow and outflow becomes equal to net cash flow from operating activities.

E.g. ADP Company prepares the cash flow statement using the direct method

This categorization is very useful as it lists out all the sources of cash inflows and outflows. However, it will be difficult to adopt by significant scale companies as they have a number of sources of finance. Due to the time consumed in its preparation, the direct cash flow method is rarely used.

What is Indirect Cash Flow?

The indirect cash flow method adjusts net income for the changes in balance sheet accounts to calculate the cash flow from operating activities. Here, the changes in assets and liability accounts that affect the cash balances during the financial year are added or deducted from the net profit before tax.

E.g. GHI Company prepares the cash flow statement using the indirect method

Companies tend to prefer the indirect cash flow method to the direct method as this method uses readily available information from the income statement and balance sheet. As such, the time spent on preparing the cash flow statement using this method is much less compared to the direct method. Therefore, the indirect method is widely used by many companies.

What is the difference between Direct and Indirect Cash Flow?

Summary – Direct Cash Flow vs Indirect Cash Flow

The difference between direct cash flow and indirect cash flow methods mainly depends on the way the net cash flow is arrived at. The resulting net cash flow under both methods is similar; however, the indirect method is preferred by many companies due to its less complicated nature. The method of calculating net cash flow from investing and financing activities remain the same irrespective of direct or indirect method is used.

References
1. “Statement of Cash Flows Direct Method | Format | Example.” My Accounting Course. N.p., n.d. Web. 10 May 2017. <http://www.myaccountingcourse.com/financial-statements/cash-flow-statement-direct-method>.
2. “IAS Plus.” Statement of cash flows: Key differences between U.S. GAAP and IFRSs. N.p., 28 July 2014. Web. 10 May 2017. <https://www.iasplus.com/en-us/standards/ifrs-usgaap/cashflows>.
3. “Statement of Cash Flows Indirect Method | Format | Example.” My Accounting Course. N.p., n.d. Web. 10 May 2017. <http://www.myaccountingcourse.com/financial-statements/cash-flow-statement-indirect-method>.

Image Courtesy:
1. “Cash Flow” (CC BY-SA 3.0) via The Blue Diamond Gallery

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