Business

Cash Flow Statement Direct Method: What Is It & Should You Use It?

Panna Kemenes

22.09.23 (updated more than 1 year ago)

Read time 3 minutes

The cash flow statement direct method shows all the cash transactions a business completes. This method shows a company’s total operating, financing, and investing cash flow over a set period.

The direct method of cash flow statement format presents a clear picture of a company’s cash flow. This method provides clarity about a company’s performance. However, it can be more difficult to prepare.

The Financial Accounting Standards Board (FASB) prefers the direct method. However, many companies use the indirect method when preparing cash flow statements.¹

🔍 In this article:
How to Create a Cash Flow Statement Using Direct Method Example of a Direct Method Cash Flow Statement Cash Flow Statement Direct vs Indirect Method Conclusion: Should You Use the Direct Method Cash Flow Statement?

How to Create a Cash Flow Statement Using Direct Method

The cash flow statement direct method format includes the following steps:

List cash collected from customers. Do not include any sales made on credit. List any interest income or dividends that your company received. Include a list of all cash paid to employees. In many cases, some companies may have a salaries payable balance. Include a list of cash paid to your suppliers. Include a list of any interest or income taxes that your company pays.

Following these steps allows you to show how your business performs on a cash flow basis.

There could be a substantial difference in performance compared to accrual figures found in the income statement;

If your customers pay on credit, you could have a high accounts receivable balance (Step #1)
If you buy a lot of supplies on credit, you could have a higher accounts payable balance (Step #4)

The direct method clears up these differences and provides a complete picture of your operating cash flow.

Example of a Direct Method Cash Flow Statement

A direct method cash flow statement includes the company’s operating, financing, and investing cash flow.

Operating activities are any activities necessary to operate a business. Investing activities are any activities related to non-current assets, such as investments.¹

Financing activities display a company’s financing structure. It shows how a company uses a combination of debt and/or equity.

Statement of Cash Flows for the Year ended December 31, 2022
Cash flow from operating activities
Cash Received from customers	1,500,000
Cash paid for materials	(200,000)
Cash paid to employees	(400,000)
Interest expenses	(30,000)
Income taxes	(170,000)
Net cash provided by operating activities	700,000
Cash flow from investing activities
Purchasing PPE	(250,000)
Net cash used in investing activities	(250,000)
Cash flow from finance activities
Proceeds from long term debt	150,000
Debt Payments	(15,000)
Net cash provided by financing activities	135,000
Net increase in Cash	585,000
Beginning Cash balance	115,000
Ending Cash balance	700,000

💡 Looking for some help with cash flow statements?
Check out the free cash flow statement templates from Wise. You can use these to calculate other formulas like free cash flow, which is the operating cash flow minus capital expenditure.

Cash Flow Statement Direct vs Indirect Method

There are several differences between these two methods that you can consider when analyzing direct vs indirect method cash flow statements.

The main difference appears in the operating cash flow section:

The direct method uses actual cash transactions and does not make any modifications
The indirect method changes the operating section from an accrual basis to a cash basis.

The indirect method begins with the net income and makes adjustments, while the direct method will show all cash transactions.

The investing and financing cash flow are similar under both methods.

Read the guide on indirect method cash flow statements

Conclusion: Should You Use the Direct Method Cash Flow Statement?

The direct method is helpful because it can provide a more detailed view of the company’s cash inflows and outflows. Below are some pros and cons to consider if you create a cash flow statement using the direct method format.

Pros:	Cons:
More detailed view of your financials Financing and investing sections are similar to those in the indirect method This method is consistent with many accounting requirements	More difficult to prepare Fewer companies use this method Not compatible with accrual accounting methods, which businesses more commonly use

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Sources:

Sources checked September 2023.

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