Indirect method cash flow
Cash flow indirect method explained and how it differs from the direct method.
Key takeaways
- The indirect method is when cash flow is calculated by taking the value of net income at the end of the reporting period and adjusting this based on the figures within the balance sheet
- The Indirect method takes net income (profit) from the income statement and modifies it to reflect actual cash flow.
- The indirect method allows you to see the difference between the stated profitability of a company with its actual cash holding position.
The indirect method is when cash flow is calculated by taking the value of net income at the end of the reporting period and adjusting this based on the figures within the balance sheet, removing the effect of non-cash movements shown on the profit and loss statement.
A cash flow statement comprises cash flow from 3 different areas, Operating, Investing and Financing cash flow.
The cash flow from the 3 sections are added together and become the opening cash balance of a reporting period.
The indirect method applies to the way the operating cash flow section of the cash balance is calculated. It takes net income and adds back the value of the non-cash transactions. For example depreciation or amortisation, increase or decrease in current assets, trade receivables (sales on credit) and trade payables (monies owed) as none of these represent actual cash in hand for the business.
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How does the Indirect method differ from the Direct method?
The direct method statement shows cash that has been received by the company or has left the company over a specific period of time, it is a direct reflection of the actual cash that the company has and the statement shows when it is coming in and when it is going out.
The Indirect method takes net income (profit) from the income statement and modifies it to reflect actual cash flow.
What are the advantages of the Indirect method?
The Direct method has to list every receipt and payment from every source, and as most companies keep records on an accrual basis, meaning that they record when a transaction occurs rather than when cash is received, the direct method can be quite time consuming to prepare. By contrast the indirect method only shows changes in current assets and liabilities so is quicker to prepare, saving time and resources.
The indirect method allows a company to see where cash flow and net income differ and where those differences are. This can help to present the financial state of the company and allows statement users to see how much the non-cash transactions contribute to profit rather than to sources of cash. The indirect method allows you to see the difference between the stated profitability of a company with its actual cash holding position.
Have you thought about invoice finance as a cash flow finance solution?
Invoice finance allows you to release cash quickly from your unpaid invoices.
As your lender, we can release up to 90% of your invoices within 24 hours. On payment of the invoice from your customers, we will then release the final amount minus any fees and charges. There are different types of invoice financing options available such as factoring (mainly invoice factoring and debt factoring) and invoice discounting to businesses depending on the situation and the level of control they require in collecting unpaid invoices.
We are an invoice financing company who offer a solution whereby payments are collected on your behalf managed by our team of expert credit controllers so you can focus on running your business. Our confidential invoice discounting solution is offered to businesses who want to maintain their own credit control processes, therefore this remains strictly confidential so your customers are unaware of our involvement.
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