Question

There are two methods to prepare the statement of cash flows. The Direct & Indirect method.

Which method do you prefer and why? Give specific reasons or examples.

Answer 1

Answer- Yes, there are two methods to prepare the statement of cash flows one is direct method and second is indirect method. Cash flow statement is a financial statement which clearly shows cash inflows and outflows of a company. It helps investors, creditors etc because by using cash flow they can choose easily where to invest.

Direct method-  In direct method, cash flow statement is prepared by taking cash receipts and cash payments and the difference of these two results is cash flow statement. In this method, non cash expenses like depreciation, Goodwill etc and non operating items are not added. In easy words, Direct method works on the cash basis.

Indirect method- In Indirect method, cash flow statement is calculated on the basis of net profit before tax, where all the non cash and non operating expenses are added, then all non cash and non operating incomes are subtracted, then decrease in Current assets and increase in Current liabilities are added and after it decrease in current liabilities and increase in current assets are deducted. So, after this a conclusion of cash flow statement from indirect method comes. In indirect method, cash flow statement is prepared on the basis of a Accrual accounting basis. So, it gives more clear result of cash flow statement.

The method which I will prefer- Indirect method.

Reasons- In indirect method, items are recorded on the basis of Accrual basis not on cash basis. Accrual basis gives clear view of cash flow statement of cash outflow and cash inflows as well as clear view of debts etc. This method is gives clear and fair view which helps management, investor's, creditors etc. By using Indirect method, Reporting of cash flow statement becomes easy as it is based on accrual basis as in business, companies, accountants works on the basis of Accrual accounting i.e the expenses and incomes are recorded when they occur not when they are received. That's why I will choose indirect method to prepare cash flow statement.