What do you believe are the most significant advantages and disadvantages of using the indirect and direct methods? Explain your reasoning.
What Is Operating Cash Flow:
A company's Operating Cash Flow can be presented using the direct or indirect method. The Operating Cash Flow shows users the net amount of cash generated or used by the company's core operations and through changes to its working capital.
Answer and Explanation:
Although any side can be argued as both methods are acceptable under GAAP, the following arguments can be used for either side.
In favor of the indirect method:
- The indirect method is much simpler to follow because it uses the working capital accounts to adjust operating cash flow.
- The indirect method takes much less time to prepare since the company only needs the trial balance instead of detailed accounts (e.g. cash receipts).
- The indirect method is more commonly used which means that users will be more comfortable seeing it.
In favor of the direct method:
- The direct method shows much more detail as to the actual cash activity occurring in operations (e.g. actual cash payments received from customers).
- The direct method can easily be "validated" by analysts by calculating the operating cash flow using the indirect method.
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from Finance 101: Principles of FinanceChapter 10 / Lesson 4