Direct method

Definition

The direct method is a way of preparing the cash flow statement by directly listing all major operating cash receipts and payments. It provides a detailed account of cash inflows and outflows from operating activities, giving a clear view of how cash is generated and used in day-to-day business operations.

5 Must Know Facts For Your Next Test

1. The direct method lists specific cash flows from operations, such as cash received from customers and cash paid to suppliers and employees.
2. It is preferred by the Financial Accounting Standards Board (FASB) because it provides more detailed information.
3. Most companies use the indirect method due to its simplicity, even though the direct method is considered more informative.
4. The direct method requires that net income be reconciled to net cash provided by operating activities in a separate schedule or note.
5. Cash flows from investing and financing activities are reported the same way under both direct and indirect methods.

Review Questions

• What distinguishes the direct method from the indirect method in preparing a statement of cash flows?
• Why does the Financial Accounting Standards Board prefer the direct method?
• What additional schedule or note must accompany financial statements prepared using the direct method?

Related terms

Indirect Method: A way of preparing the statement of cash flows where net income is adjusted for changes in balance sheet accounts to calculate operating cash flow.

Operating Activities:

Transactions involving day-to-day business functions like sales, purchases, wages, and other expenses.

Cash Flow Statement:

A financial statement that shows how changes in balance sheet accounts affect cash and cash equivalents.