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Indirect vs. Direct Cash Flow Statements

Posted on July 26, 2016 10:00 am;

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By Rebecca Langdon

 

The cash flow statement is a fundamental part of the set of accounts. There are two methods of

producing cash flow statements; indirect, and direct. The purpose of this article is to differentiate

between the two, which will hopefully be a useful reminder for those currently studying for their CFA, CMA or

CPA. Before we get into the detail, I just thought to let you know that the majority of companies use the

indirect method.

 

The first section of the cash flow statement covers the operating activities of the company. In the

indirect method net income is shown as well as the adjustments required to convert the total net

income into the cash from operating activities. Under the direct method the cash flows from the

operating activities include amounts for lines including cash out to suppliers and cash in from customers.

The direct method provides a greater level of detail than the indirect method.

 

The debate

There is some debate over which method is better. Those in favor of direct argue that it better fulfills

clients’ needs for information because it breaks down the major categories of cash inflows and outflows.

They also argue that the format is easier to understand. Those in the indirect camp say that it helps

users determine why there is a difference between net income and cash receipts and payments. The

majority of companies use the indirect method as they argue it would be far too costly to use the direct

method, even though it would arguably result is more useful information.

 

In conclusion

It is useful to highlight that whilst the methods are different, the result and both methods always be the

same. However there is clear argument over which method is most useful.

We hope this has served as a useful recap for those of you that are studying or revising for exams. Or

perhaps you are not currently enrolled, but are interested in a certified finance or accounting

qualification. If that is the case, we would welcome you to take a look at the CMACPA and CFA course

outlines.

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