The direct method cash flow statement presents operating cash flows from the “top down”, according to the sources and uses of cash. In contrast, the indirect method starts with net income and adds or subtracts changes in working capital accounts until net income is reconciled with operating cash flow.
Typical cash flow sources presented on a direct cash flow statement include cash collected from customers, and cash received from nonoperating sources. To calculate cash collected from customers, we begin with revenues as presented on the income statement. We then subtract out any changes in accounts receivable over the period. We do this because an increase in accounts receivable represents sales for which payment has not been received. Likewise, we identify any nonoperating sources of revenue and adjust for any associated accruals on the balance sheet.
Typical cash flow uses include cash paid to suppliers, cash paid to employees, cash paid for taxes, and cash paid for interest. To calculate these cash uses, we adjust each line item for the corresponding accrual.
The direct method cash flow statement and indirect method cash flow statement differ only in the presentation of operating cash flows. The cash flow from financing activities and cash flow from investing activities sections are the same under both methods.
Although the direct method cash flow statement provides the user with more information than provided by the indirect method, the direct method is more difficult to prepare. As a result, companies generally only report cash flows under the indirect method.
