Direct or Indirect Cash Flow: Which Is the Right Fit for Your Business? | QuickBooks Canada | QuickBooks Canada Blog (2024)

FAQs

Which is better, the direct or indirect method of cash flow statement? ›

The indirect method backs into the net operating cash flow value using the calculated net income and non-cash adjustments, so there is more room for errors and redundancies. Instead, the direct method is more clear in how it's calculated and can give you a better idea of your current cash standing.

Whenever given a choice between the indirect and direct methods in similar situations, accountants choose the indirect method almost exclusively. The American Institute of Certified Public Accountants reports that approximately 98% of all companies choose the indirect method of cash flows.

Although both cash flow reporting methods meet Generally Accepted Accounting Practices (GAAP) and International Financial Reporting Standards (IFRS), the guidelines encourage the direct method.

The indirect method and the direct method result in the same net cash flow from operating activities, but they differ in the presentation and the calculation. The indirect method is more common and easier to prepare, as it uses the data from the income statement and the balance sheet, which are readily available.

Some key benefits of the indirect method include: Simpler preparation: The indirect method minimizes manual cash flow calculations and instead relies on net income and balance sheet changes. This streamlines financial statement preparation.

It's easier to calculate using information from the other financial statements, and can better show the relationship between your net income and the cash flow generated during the period.

While both are ways of calculating your net cash flow from operating activities, the main distinction is the starting point and types of calculations each uses. The indirect method begins with your net income. Alternatively, the direct method begins with the cash amounts received and paid out by your business.

The indirect method is often easier to use than the direct method since most larger businesses already use accrual accounting. The complexity and time required to list every cash disbursem*nt—as required by the direct method—makes the indirect method preferred and more commonly used.

The indirect method of calculating cash flow

Since it's simpler than the direct method, many small businesses prefer this approach. Also, when using the indirect method, you do not have to go back and reconcile your statements with the direct method.

The direct method of preparing a cash flow statement has some drawbacks compared to the indirect method. It requires more data collection and analysis, as it tracks the cash receipts and payments from each operating activity separately.

What are the advantages of indirect method? ›

The main advantage of the indirect method is that it is easier and faster to prepare than the direct method. You can use the information from your income statement and balance sheet to calculate the cash flows from operating activities, without having to track and record every cash transaction.

A direct method is easier to interpret as it simply lists all the major operating cash receipts and payments during the period. Money coming into the business, usually from customers, is listed under cash inflows.

The indirect method adjusts net income with changes applied from non-cash transactions. Not commonly used. It is most appropriate for small businesses without significant cash transactions. Commonly used by public companies with regular audits.

The Direct Method deliberately prioritises listening and speaking skills. This is in stark contrast to the grammar-translation method where, because of the focus on linguistic structures, reading and writing skills are primarily developed.

Direct Cash Flow Method

The direct method adds up all of the cash payments and receipts, including cash paid to suppliers, cash receipts from customers, and cash paid out in salaries. This method of CFS is easier for very small businesses that use the cash basis accounting method.

While both the direct and indirect cash flow statement format provides you with the same end result, it's important to note that the International Accounting Standards Board (IASB) favours the direct method, as it provides more useful information.

According to FASB, that information can be presented within the statement of cash flows by either of two approaches: the direct methodA mechanical method of reporting the amount of cash flows that a company generates from its operating activities; it is preferred by FASB because the information is easier to understand ...

The direct method is more ideal for small businesses because the smaller the business, the less diverse your income sources and expenses usually are. You may also have fewer non-cash assets in general, making the direct method a better way of showing your business' true cash flow amounts.