Investor's wiki
en English
Navigation
Home Glossary
InvestingStocksBondsCryptoPersonal FinanceFundamental AnalysisTechnical AnalysisTradingBankingTaxes
Disclaimer Terms of Use Privacy Policy Cookie Policy
Navigation
Home Glossary
InvestingStocksBondsCryptoPersonal FinanceFundamental AnalysisTechnical AnalysisTradingBankingTaxes
Disclaimer Terms of Use Privacy Policy Cookie Policy

Indirect Method

Indirect Method
BusinessCorporate Finance and AccountingAccounting

What Is the Indirect Method?

The indirect method is one of two accounting medicines used to produce a cash flow statement. The indirect method involves increases and diminishes in balance sheet details to adjust the operating section of the cash flow statement from the accrual method to the cash method of accounting.

The other option for finishing a cash flow statement is the direct method, which records genuine cash inflows and outflows made during the reporting period. The indirect method is all the more commonly utilized in practice, particularly among bigger firms.

Grasping the Indirect Method

The cash flow statement basically centers on the sources and uses of cash by a company, and it is closely observed by investors, creditors, and different partners. It offers data on cash produced from different activities and portrays the effects of changes in asset and liability accounts on a company's cash position.

The indirect method presents the statement of cash flows beginning with net income or loss, with subsequent augmentations to or deductions from that amount for non-cash revenue and expense things, bringing about cash flow from operating activities.

The indirect method is simpler than the direct method to prepare on the grounds that most companies keep their records on an accrual basis.

Illustration of the Indirect Method

Under the accrual method of accounting, revenue is recognized when earned, not really when cash is received. In the event that a customer purchases a $500 gadget on credit, the sale has been made however the cash has not yet been received. The revenue is as yet recognized in the period of the sale.

The indirect method of the cash flow statement endeavors to return the record to the cash method to portray genuine cash inflows and outflows during the period. In this model, at the hour of sale, a debit would have been made to accounts receivable and a credit to sales revenue in the amount of $500. The debit increases accounts receivable, which is then shown on the balance sheet.

Under the indirect method, the cash flows statement will introduce net income on the main line. The accompanying lines will show increases and diminishes in asset and liability accounts, and these things will be added to or deducted from net income in light of the cash impact of the thing.

In this model, no cash had been received except for $500 in revenue had been recognized. Consequently, net income was exaggerated by this amount on a cash basis. The offset was sitting in the accounts receivable detail on the balance sheet. There would should be a reduction from net income on the cash flow statement in the amount of the $500 increase to accounts receivable due to this sale. It would be shown as "Increase in Accounts Receivable (500)."

Indirect Method versus Direct Method

The cash flow statement is separated into three classifications — cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Albeit total cash created from operating activities is similar under the direct and indirect methods, the data is introduced in an alternate configuration.

Under the direct method, the cash flow from operating activities is introduced as genuine cash inflows and outflows on a cash basis, without starting from net income on an accrued basis. The investing and financing sections of the statement of cash flows are prepared similarly for both the indirect and direct methods.

Numerous accountants favor the indirect method since it is simple to prepare the cash flow statement utilizing data from the other two common financial statements, the income statement and balance sheet. Most companies utilize the accrual method of accounting, so the income statement and balance sheet will have figures reliable with this method.

Be that as it may, the Financial Accounting Standards Board (FASB) lean towards companies utilize the direct method as it offers a clearer image of cash flows all through a business. Notwithstanding, on the off chance that the direct method is utilized, it is as yet prescribed to do a reconciliation of the cash flow statement to the balance sheet.

Features

  • Under the indirect method, the cash flow statement starts with net income on an accrual basis and subsequently adds and takes away non-cash things to accommodate to genuine cash flows from operations.
  • The indirect method is frequently more straightforward to use than the direct method since most bigger businesses as of now use accrual accounting.
  • The complexity and time required to list each cash payment — as required by the direct method — makes the indirect method preferred and all the more commonly utilized.