What are the differences between the direct and indirect presentation of cash flows? Why does the Financial Accounting Standards Board allow both methods? Which do you prefer? Why?
The Cash Flow Statement has three sections: Cash Flow from Operating Activities, Cash Flows from/for Investment Activities and Cash Flows from/for Financing Activities. The Direct Method is less commonly used than the Indirect Method. [ [ What is the Direct Method? It adds up the cash flows (as opposed to accruals, which the income statement and balance sheet are based upon) in and out of the
business in each of the three areas of Operations, Investments and Financing. The upside to the Direct Method is that it is easy to understand (money in, money out = what's left over), but the downside is that it isn't much help except in tell you what you already know. That is, it tells you some money came in, money came out and you have money left over. The Direct Method is more common in Commonwealth countries (e.g Australia) for some reason, but I'm not sure why. The Indirect Method is the much more common method, which starts with Net Profit (or another profit line item) and then adjusts the balance for non-cash items (e.g. depreciation), changes in balance sheet items (e.g. accounts receivables, accounts payable, inventory). The Indirect Method is less intuitive when looking at it by itself, but is much more helpful when used in conjuction with the income statement and balance sheet. ] ]
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