Direct vs. Indirect Method of Cash Flow Preparation

A cash flow statement helps evaluate a company’s liquidity and operational efficiency. It can be prepared using the direct or indirect method.

Take Gamma Corporation as an example.

It earned two hundred and twenty thousand dollars in sales revenue during the year.

After accounting for a twenty‑thousand‑dollar increase in accounts receivable, the actual cash collected from customers was two hundred thousand dollars.

It also recorded ten thousand dollars in asset depreciation. The company made cash payments of one hundred twenty thousand dollars to suppliers and thirty thousand dollars to employees.

Using the direct method, which converts each income statement item to a cash basis, Gamma reports actual cash inflows and outflows, resulting in fifty thousand dollars of net cash from operating activities.

Under the indirect method, Gamma starts with net income, assumed to be sixty thousand dollars, adds back depreciation, and subtracts the increase in accounts receivable.

This results in fifty thousand dollars of operating cash flow.

While the direct method shows specific cash flows, the indirect method adjusts net income.

Most companies prefer the indirect method because it is simpler to prepar