When it comes to the preparation of financial statements, one will need to master a lot of skills and methods required to generate those statements accurately. This is why some of the business owners prefer hiring an accounting firm in Singapore to get this done rather than completing this task on their own. Among the crucial financial statements, the cash flow statement is the one that people require so that they get to know the sum of cash that goes into and out of the company.
In the cash flow statement, there are three types of cash flow activities, which are the operating activities, investing activities and financing activities. Usually, the accountants will calculate the amount of cash flow for investing activities and financing activities by using similar methods. However, in the case of the calculation for operating activities, there are two methods that they can use, which are the direct method and the indirect method.
If one uses the direct method, he should record all the changes in cash receipts and payments under the section of cash flow from operating activities in the statement. If he prefers using the indirect method, he needs to adjust the changes in the company’s assets and liabilities in its net income when calculating the sum of cash flow from operating activities.
The direct method only includes cash transactions to generate a cash flow statement. In other words, it only takes the cash receipts and cash payments into account. Typically, the direct method shows the gross cash receipts and cash payments of specific line items. Some examples include the cash that the company has received from its customers, paid to the suppliers for the goods and services bought, as well as cash payments to the employees. Other receipts or payments include the interests and taxes paid, and other cash received or paid.
On the other hand, the indirect method takes the company’s net income as a base before adding the non-cash expenses incurred and deducting all non-cash incomes from it. The former may include depreciation and amortisation expense, while an example for the latter is the sale of scraps. Also, he needs to make some adjustments before producing the cash flow statement.
In conclusion, both the direct method and indirect method for the preparation of cash flow from operating activities have their own advantages and disadvantages. Business owners or the accountants (Also see How Do the Accountants Reconcile the Accounts?) may decide the method they want to use based on their needs and situation.