Direct Vs Indirect In Creating A Cash Flow Statement
Cash flow is a financial statement which describes the cash effect due to business operation, investment, or financing within 0one specific period.

Most companies use accrual accounting which the income statement tells little about cash flowing into and out of the business. In order to give a better understanding of cash flow, the companies turn to the cash flow statement, which covers the section that restates income on a cash basis. There are two methods to report the cash flow, direct and indirect methods.

There are three activities stated in the statement of cash flow: operating, investing, and financing. Among these activities, only operation dealing with method selection, indirect or direct cash flow. Comparing the operation part with the income statement enable the owner to identify the difference between expenses and cash collections.

The flow of cash flow

There are two types of the flow of cash flow:

  1. Cash in flow

Cash inflow is a cash flow that occurs from transactions that generate cash profit (cash receipts). Cash inflow consists of:

  • Sales of company products / services.
  • Collection of accounts receivable from credit sales.
  • Sales of existing fixed assets.
  • Received investments or shares
  • Loans / debts from other parties.
  • Rental receipts and other income.
  1. Cash out flow

Cash out flow is the cash flow that occurs due to the transaction activities that result in cash expenditure charge. The cash out flow consists of:

  • Expenses on raw materials, direct labor and other factory costs.
  • General administration expenses and sales administration.
  • Purchase of fixed assets.
  • Payable payment
  • Lease payments, taxes, dividends, interest and other expenses.

There are two methods to present cash flow statement, direct and indirect methods. The difference between these methods lies in the cash flow due to operational activities.

In direct method, the cash flow from business activities are broken down into cash inflows and cash outflow. Meanwhile, indirect method, the operational cash flow is determined by correcting the reported net income in income statements. Basically, indirect method is a reconciliation of net income earned by the company. It describes the relationship among cash flow statement, income statement, and balance sheet.  In the indirect method, net cash flows obtained from operating activities are determined by adjusting the net profit or loss due to:

  1. Changes in inventories, receivables, and payable during the year.
  2. Non-cash items such as depreciation, allowance, profit and losses, unrealized foreign exchange

3 All other items relates to investment cash flow and financing.

Monitoring cash flow statement is taken to measure the company’s liquidity . Cash deficiency will cause the business collapse.