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Direct And Indirect Cash Flow Method

923 words - 4 pages

Direct Vs. Indirect Cash Flow Method
A company reports revenues and expenses on its income statement. Since most companies use accrual accounting, the income statement reveals little about cash flowing into and out of the business. To provide an understanding of cash flows, companies turn to the cash flow statement, which includes a section that restates income on a cash basis. You can choose between the direct and indirect methods to report operational cash flow.
Cash Flow Statement
The statement of cash flows contains sections for three sets of activities: operating, investing and financing. Only the operations section deals with the question of direct versus indirect cash flows. By ...view middle of the document...

You also adjust net income for changes between the starting and ending account balances in current assets -- excluding cash -- and current liabilities for the period. These accounts include accounts receivable, inventory, supplies, prepaid assets, payable liabilities and unearned revenues.
Considerations
The indirect method uses readily available information and most companies find it easier to employ. Management and shareholders might fret if a company consistently reports net income exceeding cash flows -- they will want to identify the sources of non-cash income and determine whether these are masking serious problems with the business. If you believe that “cash is king,” you will look to the cash flow statement to measure the company’s liquidity -- the ability to pay bills and avoid defaulting on debt. Cash shortages can lead to bankruptcy, whereas excess cash might indicate a need to take steps such as increasing investments, paying down debt, increasing executive salaries or distributing dividends.

Direct Vs. Indirect Cash Flow Method
Companies that use the accrual method of accounting typically prepare a cash flow statement each month to figure out when they can expect the inflow of cash to the company. Officially called the statement of cash flows, the accounting department can choose between two preparation methods for the cash flow statement -- direct and indirect. Each method approaches cash flow reporting from a different perspective, although each result in the same ending number for the accounting period.
Direct Method
* The cash flow statement direct method identifies a company’s sources and cash uses divided into three sections that contain cash receipts and cash payments. These sections include operating, investing and financing activities. Operating activities include receipts and payments from normal business operations, while investing activities include the purchase or sale of long-term asset and investments. The financing activities relate to borrowing money...

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