Main Difference between Direct and Indirect Method of SCF
The main difference between the direct method and the indirect method of presenting the statement of cash flows (SCF) involves the cash flows from operating activities. (There are no differences in the cash flows from investing activities and/or the cash flows from financing activities.)
Under the U.S. reporting rules, a corporation has the option of using either the direct or the indirect method. However, surveys indicate that nearly all large U.S. corporations use the indirect method.
Example of the Indirect Method of SCF
When the indirect method of presenting a corporation’s cash flows from operating activities is used, this section of SCF will begin with a corporation’s net income. The net income is then followed by the adjustments needed to convert the accrual accounting net income to the cash flows from operating activities. A few of the typical adjustments are:
- Adding back depreciation expense
- Adding the decrease in accounts receivable
- Deducting the increase in inventory
- Deducting the decrease in accounts payable
- Adding the increase in accrued expenses payable
Example of the Direct Method of SCF
When the direct method of presenting a corporation’s cash flows from operating activities is used, the amount of net income is not the starting point. Instead, the direct method lists the cash amounts received and paid by the corporation. Here are a few of the more common descriptions that will be seen under the direct method:
- Cash from customers
- Cash paid to employees
- Cash paid to suppliers
- Cash paid for interest
The direct method also requires a reconciliation of net income to the cash provided by operating activities. (This is done automatically under the indirect method.)
