Direct vs Indirect Cash Flow Methods

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Direct vs. Indirect Cash Flow Differences

The cash flow statement contains three activities, namely operating, investing, and financing. Usually, the investing and financing sections are calculated similarly.

But when it comes to calculating cash flow from operational activity, two methods of calculation are majorly used – indirect method and direct method.

Direct vs Indirect Cash Flow Methods
  • The indirect method of cash flow uses net income as the base. It makes the necessary adjustments, i.e., adding and subtracting the variables to convert the total net income to cash from operations.
  • The direct method of cash flow in operating activities includes the cash being received from the customers and the cash paid to the suppliers, employees, and others. The cash can also be paid for income tax, interest, and other variables.
  • The direct cash flow method starts with cash transactions such as cash received and cash paid while ignoring the non-cash transactions.
  • Indirect cash flow method, on the other hand, the calculation starts from the net income, and then we go along adjusting the rest.
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Direct and Indirect Cash Flow Methods Infographics

Here are the top 7 difference between Direct and Indirect Cash Flow Methods

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Direct vs. Indirect Cash Flow Methods Explained in Video

Direct Cash Flow vs. Indirect Cash Flow Method  Key Differences

Here are the key differences between direct vs. indirect cash flow methods–

  • One of the key differences between direct cash flow vs. indirect cash flow method is the type of transactions used to produce a cash flow statement. The indirect method uses net income as the base and converts the income into the cash flow through adjustments. The direct method only takes the cash transactions into account and produces the cash flow from operations.
  • The cash flow indirect method makes sure to automatically convert the net income in terms of cash flow. The cash flow direct method, on the other hand, records the cash transactions separately and then produces the cash flow statement.
  • The cash flow indirect method needs preparation as the adjustments that are made require time. The preparation time for the cash flow direct method isn’t much since it only uses cash transactions.
  • The accuracy of the cash flow indirect method is a little less as it uses adjustments. The cash flow direct method is more accurate as adjustments are not used here.

So, what are the differences between direct and indirect cash flow methods? First, let’s look at the head-to-head differences between the direct and indirect cash flow methods.

Direct vs. Indirect Cash Flow Method Head to Head Differences

Here are the basic differences between direct vs. indirect cash flow methods

The basis for comparison between Direct vs. Indirect Cash FlowsCash flow indirect methodCash flow direct method
DefinitionThe indirect method uses net income as a base and adds non-cash expenses like depreciation, deducts non-cash incomes like profit on the sale of scraps, and net adjustments between current assets & liabilities to produce the overall cash flow statement.The direct method uses only the cash transactions, i.e., cash spent and cash received to produce the cash flow statement.
WorkingNet income is automatically converted in the form of cash flow.Reconciliation is done to separate the cash flow from others.
Factors are takenAll the factors are taken into account.All non-cash transactions like depreciation are ignored.
PreparationsPreparations are mainly needed during the conversion of net income into cash flow statement.There’s no such preparation required.
AccuracyThe cash flow statement under the indirect method is not very accurate as adjustments are being made.The Cash flow statement under the direct method is very accurate as there is no need for any adjustments here.
Time takenIt takes less amount of time compared to the direct method.It takes more amount of time compared to the indirect method.
PopularityMany companies predominantly use this method.Compared to the indirect method, they are only a very few companies that use this method.

Direct vs. Indirect Cash Flow Method - Conclusion

The direct vs. indirect cash flow method is useful at different points, and it can be used depending on the situation and the requirement. The indirect method is the most popular among companies. But it takes a lot of time to prepare (before recording), and it’s not very accurate as many adjustments are used.

On the other hand, the direct method doesn’t need any preparation time other than segregating the cash transactions from the non-cash transactions. And it’s more accurate than the indirect method.