Every company must ensure the smoothness of its cash flow. This smoothness of cash flow can be monitored through systematically prepared cash flow reports. These monitored cash flows are divided into two categories: direct and indirect cash flow.
The difference between direct and indirect cash flow lies in the way they are presented in the cash flow statement, particularly in the operating activities section. Each type of cash flow has a different approach to describing how cash is generated and used in a company's operational activities.
Some people may still be unfamiliar with these two differences. Therefore, to help you better understand them, here is some information about the differences between direct and indirect cash flow. Let's take a look!
What Are Direct and Indirect Cash Flow?
Direct cash flow is a method of preparing a cash flow statement that directly records all cash receipts and disbursements from a company's operational activities.
In this method, every cash transaction occurring during a specific period is displayed in detail, such as cash received from customers, payments to suppliers, salary payments, and other operating expenses.
This method provides a clearer and more transparent picture of the actual cash flow in and out of a company's operations. While more informative, this method requires more detailed record-keeping, making its preparation more complex than the indirect method.
Meanwhile, the indirect cash flow method is a method of preparing a cash flow statement that starts with net income and then adjusts for non-cash transactions and changes in balance sheet accounts to calculate cash flow from operating activities.
These adjustments include items such as depreciation, amortization, and changes in accounts receivable, inventory, and accounts payable. The goal is to convert accounting profit figures into the actual cash received or paid by the company.
The indirect method is more frequently used because the data is easily retrieved from the income statement and balance sheet, and it does not require detailed recording of cash transactions as in the direct method.
Differences Between Direct and Indirect Cash Flow
Direct and indirect cash flow have several differences, including operational activities. As reported by Indeed, here are some important differences between direct and indirect cash flow.
1. Definition
The first difference between direct and indirect cash flow lies in the definition. The direct method presents data based on actual figures directly and only records cash flows that actually occur, both in the form of cash receipts and disbursements.
Meanwhile, the indirect method starts with net income and is then adjusted for various changes due to non-cash transactions to obtain a true picture of operational cash flow.
2. Usage
These two cash flow categories also differ in their usage or usage preferences. Direct cash flow is generally used by small businesses that do not have significant cash transactions.
Meanwhile, indirect cash flow is generally used by public companies that conduct regular audits. This is because indirect cash flow uses information from the income statement and balance sheet, allowing for immediate review of its accuracy.
3. Accuracy
Direct cash flow is easy to understand through reports, but it is often difficult to calculate. Meanwhile, indirect cash flow tends to be easier to calculate through the company's general ledger and accrual accounting system.
4. Preparation Time
The direct cash flow method is less suitable for the bookkeeping needs of some types of organizations. This method requires detailed recording of all cash receipts and disbursements. This makes the preparation process longer and labor-intensive.
In contrast, the indirect cash flow method is usually easier to prepare with minimal effort, as most organizations already record their financial transactions using the accrual basis.
5. Cash Revenue Reconciliation
The direct cash flow method requires a reconciliation process to verify transactions, as reports are prepared based on real-time data.
The indirect cash flow method, on the other hand, reconciles net cash flow based on accrual accounting with actual cash flow from operating activities. This helps uncover discrepancies between the company's actual cash holdings and the profit recorded in the financial statements.
6. Link Formation
The difference between direct and indirect cash flow also lies in the link formation. With direct cash flow, the recording process is carried out in real time, allowing the recorded figures to be directly linked to the balance sheet, ultimately showing the direct flow of financial data.
Meanwhile, the indirect cash flow method requires a clear link between the balance sheet and the income statement. This approach helps provide a more structured and comprehensive picture of the company's financial condition.
Simple Examples of Direct and Indirect Cash Flow
Based on the differences above, the final results obtained by each cash flow reporting method may be the same. However, differences can be seen in the calculation or presentation methods. The following are examples of direct and indirect cash flow that can be understood.
Examples of Direct Cash Flow
Cash Flow from Operating Activities:
Cash receipts from customers: Rp 200,000,000
Payments to suppliers: (Rp 100,000,000)
Payments to employee salaries: (Rp 50,000,000)
Payments for other operating expenses: (Rp 20,000,000)
Net Cash from Operating Activities: Rp 30,000,000
Example of Indirect Cash Flow
Cash Flow from Operating Activities:
Net income: Rp 40,000,000
Adjustments for:
Depreciation: Rp 10,000,000
Decrease in accounts receivable: Rp 5,000,000
- Increase in inventory: (Rp 10,000,000)
- Decrease in accounts payable: (Rp 15,000,000)
Net Cash from Operating Activities: Rp 30,000,000
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