How to Create a Cash Flow Statement Using the Indirect Method

Whether you choose to use the indirect or direct method will affect the way you operate your cash flow and the story you tell around it. So make sure you choose the method that puts you in the best place to help your business succeed. Under GAAP and indirect cash flow vs direct IFRS, the indirect method is preferred or sometimes required, so many companies opt for it to save time and comply with regulations. Once you’ve considered what you’re trying to do with your cash flow statement, one method will make more sense.

Another advantage of the direct method is the specificity and insights it provides compared to the indirect method. Under the U.S. reporting rules, a corporation has the option of using either the direct or the indirect method. However, surveys indicate that nearly all large U.S. corporations use the indirect method. Once you’re done with the adjustments, you end up with a final closing bank position. But as your business grows, using the direct method becomes less practical.

Why Use the Indirect Method of Cash Flow?

Alternatively, the direct method begins with the cash amounts received and paid out by your business. On the other hand, the indirect method is much easier for the finance team to create but harder for outside readers to interpret. It might be a better option for leaner teams who don’t have the time or resources to follow the direct method.

This means you may need to take additional actions, such as accounting for earnings before taxes and interest, and making adjustments for non-operating expenses such as accounts payable and depreciation. The direct method for cash flow statements can provide a more granular and accurate view of your current financial position. The indirect method is one of two accounting treatments used to generate a cash flow statement. The indirect method uses increases and decreases in balance sheet line items to modify the operating section of the cash flow statement from the accrual method to the cash method of accounting. Although it has its disadvantages, the statement of cash flows direct method reports the direct sources of cash receipts and payments, which can be helpful to investors and creditors.

Direct vs Indirect Method Cash Flow Statement

Under the direct method, the only section of the statement of cash flows that will differ in the presentation is the cash flow from the operations section. The direct method lists the cash receipts and cash payments made during the accounting period. Under the direct method, the cash flow from operating activities is presented as actual cash inflows and outflows on a cash basis, without starting from net income on an accrued basis. The investing and financing sections of the statement of cash flows are prepared in the same way for both the indirect and direct methods.

Direct cash flow reporting takes a long time to prepare because most businesses work on an accrual basis. In this article, we’ll go over how to create your cash flow statement by smashing together the income statement and balance sheet. Direct technique presents operating cash flows as a list of incoming and departing cash flows. The direct method, in essence, subtracts the money you spend from the money you receive. Thus, many companies will choose to only utilize the indirect method to save their team the time of having to prepare the cash flow statement using both methods. The indirect method lacks such deep insights since the net cash flow metric is indirectly calculated from the other financial statements.

Indirect Cash Flow Method Example

Direct cash flow forecasting relies on real-time cash transaction data, which may not be readily available in some cases. If you lack direct cash flow data, indirect forecasting based on financial statements can be a viable alternative. Direct forecasting relies on real cash flow data, making it accurate in the short term. However, it becomes less reliable as you move further into the future due to the scarcity of real data. Meanwhile indirect forecasting uses projected financial statements, which are useful for long-term planning.

Historically financial modeling has been hard, complicated, and inaccurate. The Finmark Blog is here to educate founders on key financial metrics, startup best practices, and everything else to give you the confidence to drive your business forward. As we mentioned above, the indirect method is the required/preferred method under GAAP and IFRS accounting regulations.

In this article, we define cash flow statements, the different cash flow methods, cover the pros and cons of each, and explore how automation can improve cash flow. Whether you use the direct or indirect method for cash flow accounting will depend largely on your company’s accounting practices. So therefore, your net profit is the result of all of the transactions that are recorded on your profit and loss report. On the indirect cash flow, you have to then work through your cash inclusions and exclusions to get to the final net cash figure.

Meanwhile, the direct method provides a precise and clear understanding but can be time-consuming and challenging for businesses with extensive transactions. Businesses must weigh the pros and cons of each method to make an informed decision, ensuring accurate financial reporting and aiding effective financial management and planning. Considering the benefits and drawbacks of direct and indirect cash flow statements, how do you choose the best one for your business?