Cash flow direct method {full information}

In this article I explained everything about the cash flow direct method.

If you want to improve your business by creating cash flow statements, you will love this information.

So, take a long breath and start reading from the basics.

What is cash flow direct method

direct method is a type of accounting treatment which is used to create a cash flow statement.

This method considers actual inflow and outflow of cash instead of revenue. It collects receipts which are paid from customers and payments which are paid to suppliers and employees.

Get net cash flow to substrate the value of payments cash from received cash. This method is also called the income statement method.

It gave more accurate data of the company but also it was time consuming work. Other hand, the indirect method is easy because it is free from making lists and instead of that, use net income for base.

Let’s know in depth.

Understand direct method

In the financial world, three major statements are considered.

• Income statement
• Balance sheet
• Cash flow statement

Cash flow statements have been divided into three parts.

• Cash flow from operating activities
• Cash flow from investing activities
• Cash flow from financial activities

For investing and financial activities, direct and indirect methods are the same, but the operating section is a little different.

Cash flow direct method uses activities with its source when indirect method is considered net income for the base and then adjusts changes in assets and liabilities.

For Prepare cash flow statement using direct method, first to make a list of cash inflow source which normally comes from company core idea and cash outflow which can be supplier and employees.

Subtract outflow of operating activities from inflow of operating activities to get net operating activities which may be positive or negative.

If positive means your business is going great but if negative then the company’s performance is poor. You need to fix this issue as soon as possible.

After getting net operating cash flow, include financial and investing activities to get net cash flow.

Now let’s understand by a example

direct method cash flow Example

First we need to know what activities are included in three parts of the cash flow statement, then it’s an easy to understand example.

Operating activities

• Cash Receipts from Customers
• Cash Paid to Suppliers
• Cash Paid to Employees
• Interest Paid
• Income Taxes Paid

Investing activities

• capital expenditures
• sale of investment securities
• expenditures in property, plant, and equipment (PPE)
• Purchase of stock and bond

Financial activities

• Issue stock (inflow)
• Repurchase shares (outflow)
• Payout debt
• Paying cash dividends

Now, assume a sgop whose name is “Paul’s guitar” creates a cash flow statement.

So, it will look like this.

It’s difficult to find a direct method cash flow Example, cause most companies use indirect method and the reason is the difficulty of that complexity.

Still I have a little example for you.

time to discuss some issues with direct method.

Problem with direct method

We can say complexity of direct method instead of problem, cause it needs more work.

When you think of using the cash flow direct method, first you need a list of all receipts from Customers and payments from suppliers and lenders.

If you have a small business then it’s not a big issue but the real problem starts when you have a large business and many transactions, then it’s very difficult to consider all of these.

Another issue is with FASB. When you use a direct method, FASB requires a Reconciliation report to check operating activities of cash flow statements.

In this report non cash expenses are adjusted from the balance sheet. In other words, from net income to adds and substrates the value of assets and liabilities. Which are similar to create indirect method.

So, it’s obvious why most companies prefer indirect method.

But it has its own benefits too. Let’s see some direct method advantages.

Cash flow direct method shows source of cash flow, that’s useful for investors and analysts.

Also this method is considered only received and payable cash, so it’s more accurate compared to indirect method.

It’s a easy for small business which don’t have much of transactions.

FAQ

Let’s see some frequently asked questions.

Conclusion

So, it’s all information about the cash flow direct method.

Now your turn, comment what you think about this.

By the way, you can check other articles on this site.