Indirect & Direct Ways to Report Operating Activities

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  • 0:00 Reporting Operating Activities
  • 0:43 Direct Method
  • 1:52 Indirect Method
  • 3:01 Operating Section Only
  • 3:30 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Knowing which method to use to prepare the operating activities section of a cash flow statement is important for making sure that your work is useful to your company. In this lesson, we go over differences between the indirect and direct methods.

Reporting Operating Activities

Practically every business has to prepare a cash flow statement, which shows how money moves in and out of the organization. And if your company isn't doing this, it should! One thing people are surprised to learn is that while the cash flow statement has three different sections, only one of them is consistently different depending on the method used to prepare it.

The Operations Section

In this lesson, we're going to look at the direct and indirect methods of preparing the operations section of the cash flow statement. As we'll see, different companies choose to use different methods for their own reasons. We'll also look at an example of each method in action.

Direct Method

The direct method of preparing the operation sections of cash flow statements is the method that is preferred by both small businesses and most professional accounting companies. The reason for this is pretty simple - the direct method gives you a much more detailed image of how cash is moving through the organization. However, you don't get as good of an idea of non-cash assets, things like depreciation and amortization of assets.

So what does the direct method entail? Simply put, there's more detail to the specifics of cash itself. As a result, a direct method statement will have line items for cash paid to suppliers, cash paid as wages, and cash revenues from customers. Also, at the end of the cash flow statement, a reconciliation is given for any income from non-cash assets, like interest.

Let's look at an example of an operations section of a cash flow statement using the direct method:

Category Income Expenses
Cash from customers $400,000
Cash paid to suppliers $150,000
Cash paid as wages $125,000
Interest paid $15,000
Income taxes paid $10,000
Net Cash Flow $100,000

Indirect Method

So what about the indirect method? This one is actually preferred by larger businesses. The reason for this is pretty simple - the indirect method places greater emphasis on non-cash assets. This is represented by amortization and depreciation. A large company may not care as much about fluctuations in price or costs, but it wants to be sure that its network of factories is still in good shape. That's what the indirect method lets us see.

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