Direct and Indirect Cash Flow

The statement of cash flows is one of the components of a company's set of financial statements. It is used to reveal the sources and uses of cash by an organization or any business. The main difference between the direct method and the indirect method involves the cash flows from operating activities, the first section of the statement of cash flows.

The indirect method of presentation is the information required for it is relatively easily assembled from the accounts that a business normally maintains in its chart of accounts. The indirect method is less favored by the standard-setting bodies, since it does not give a clear view of how cash flows through a business as the one that are shown under the direct method of presentation. The direct method, unlike the indirect method, reveals operating cash receipts and payments. Using the direct method may require that the chart of accounts be restructured in order to collect different types of information. Instead, they use the indirect method, which can be more easily derived from existing accounting reports.

The Financial Accounting Standards Board allow the option of reporting either the direct or indirect method when preparing statement of cash flows. The FASB consider the direct method as the preferred method of presenting cash flows from operations. The direct method is easier to comprehend, as it takes into account all major classes of cash payments and receipts to arrive at a net cash position for cash from operating, investing, and financing activities. The indirect method uses a company's net income, as reported from its income statement, as a starting point before making adjustments for all cash and non-cash related items to arrive at a cash position. Cash from operating activities lists net income and adds non-cash expenses such as depreciation to net income.

The Financial Accounting Standards Board encourages businesses to report cash flows from operating activities directly by showing major...