Direct vs. Indirect Method Statement of Cash Flows

This video compares and contrasts the direct method for preparing the Statement of Cash Flows to the indirect method for preparing the Statement of Cash Flows.

Regardless of whether the indirect method or direct method is used, the Statement of Cash Flows has three sections: operating, investing, and financing. The investing section and financing section are prepared in the exact same way for the indirect method and direct method. Thus, it is the way in which the operating section is prepared that makes the indirect method and direct method different.

With the direct method, the operating section of the Statement of Cash Flows is simply a cash-basis Income Statement. Thus, the operating section is prepared by going line-by-line through the company's Income Statement and converting each line item to its cash-basis (sales revenue is converted to cash received from customers, cost of goods sold is converted to cash paid to suppliers, etc.). Non-cash charges such as depreciation expense are not included in the operating section because they do not affect cash and would not appear in a cash-basis Income Statement.

In contrast, the indirect method calls for the operating section to be prepared by starting with Net Income (from the Income Statement) and making adjustments to Net Income. The adjustments are based on changes in the company's current assets and current liabilities. Also, non-cash charges such as depreciation expense or impairment charges are added back to Net Income as an adjustment (also, any gains are subtracted from Net Income as an adjustment).

You obtain the same Net Cash Flow from Operating Activities whether the direct method or indirect method is used. The direct method's operating section is easier to understand because all cash receipts and cash payments are clearly listed, but the indirect method is much more frequently used by companies.—
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[davidsera]

hi all, been reading comments and many seem confused about where the numbers for direct come from, the conversion are a combination of IS and BS information.
the sales 300k --> 440k is simply taking the 300k + 30k from decrease in AR (decrease in AR means we collected cash) + 110k increase in unearned revenue (means we got paid for work ahead of time without doing the work)
the COGS 50k --> 70k is taking the 50k of COGS + 40k increase in inventory (purchases made but not yet sold) - 20k increase in AP (purchases we have yet to pay for)
the interest of 10k --> take the 10k and add the 2k decrease in interest payable (payable decreasing means we made payments)
finally,
the income tax of 8k --> take the 8k and add the 1k decrease in income tax payable (same reasoning as interest payable)

[jesusnoeserna]

finally someone who can explain accounting clearly Thanks!

[far]

Thank you Michael. This is really helpful. I'm not sure how to show my gratitude to you, you made all my accounting courses easier!

[mirhasan]

Hi! Arya roohi, that's the solution of ur question! Sales revenue 300k +decrease in account receivables 30k + unearned revenue 110k=440k cash received from customer

[devoos]

Hi I love your vids your basically been my number one professor in my education. But can you explain the numbers on the direct method please? I don't understand where you got the changing numbers from

[jameskarlcacnio]

Thank you for your video! It helps me to identify those accounts from SFP for Indirect Method in CFS.

[ViniciusAlves-rejv]

Thanks for the help! Very good explanantion.

[MyFinancialFocus]

I definitely prefer the indirect method. I like seeing the noncash line items get adjusted on the cash flow statement.

[Billonator]

Why is cash received from customers 440, 000 when sales revenue is only 300, 000? Where does the rest come from?

[samkab]

Can u please explain more the direct model

[edmundsoh]

You saved me! thank you! my exams are just 21 hours away

[benl.]

Will an increase in accounts receivable affect operating activities?

[darylcheung]

Just in case anyone is confused, Depreciation expense under INDIRECT METHOD is added back to operating section as it is an non-cash item. Meanwhile, Depreciation expense under DIRECT METHOD has NO ADJUSTMENT (IGNORED.

[aedriannemarieestolero]

why sales revenue become 440k in cash flow? when it is only 300k only in income statement?

[amirmh]

Thanks for the video, Michael!
I tried to do the indirect method on an actual financial statement, but the AR and Inventory delta (example: AR 2022 - AR 2021) do not match with the amount listed in the CFO for changes in AR and Inventory. Any idea why?

[sfundomahlobo]

sir, I thought we use the profit before tax instead of net profit for the indirect method, is it not so?

[wahidurrahman]

how u calculate receive from customer amount 4, 40, 000 ?

[Kinga]

For indirect CF statement, why is Wages Payable not showing as ($20, 000)?

[ifzpqmj]

Depreciation expense (a non cash expense) on a cash flow statement???

[aryaroohi]

its been two or three videos you keep saying you'll get into how to go from 300k in revenue to 440k in cash from customers but we have yet to get into it. and by the next video we're on a different topic and never revisit this. could you please explain how/what we converted to go from revenue to cash received from customers please?