What is the Indirect Method
The indirect method is an accounting treatment used to generate a statement of cash flows which a company may use during any given reporting period. The indirect method uses accrual accounting information to present the cash flows from the operations section on their cash flow statement.
Many accountants prefer the indirect method because it’s fairly easy to prepare from the accounts businesses ordinarily maintain as part of the chart of accounts. However, regulators and standards-setting bodies are less in favor of its use as it doesn’t offer a clear a picture of cash flows throughout a business.
BREAKING DOWN Indirect Method
The statement of cash flows is one piece of a company's set of financial statements. Its use primarily centers on the sources and uses of cash by a business – which is closely monitored by investors, credits and stakeholders alike. It offers information into cash generated from operations and the effects of various changes in the balance sheet on a company's cash position. The indirect method presents the statement of cash flows beginning with net income or loss, with subsequent additions to or deductions from that amount for non-cash revenue and expense items, resulting in net income from by operating activities.
When using the indirect method, cash flows are divided as:
- Cash flows from operating activities
- Cash flows from investing activities
- Cash flows from financing activities
Although total cash generated from operating activities is the same under the direct or indirect methods, the information is presented in a different format.
The investing and financing sections of the statement of cash flows are prepared in the same way for both the indirect and direct methods.