Cash flow is the lifeblood of any organisation. It's a key indicator of financial health, showing how well a company can generate and manage cash to meet obligations, invest and grow.
Yet, cash flow management for growing businesses can become a headache if it's not dealt with effectively. To do this, business owners need to be aware of the different cashflow methods, notably indirect and direct, and decide which to use.
In this article:
Cash flow is the net amount of cash and cash equivalents moving in and out of a business over a specific period. It's a key benchmark of financial performance, providing insight into a company's ability to generate cash from its core operations, investments and financing activities.
Improving cash flow in a growing business is imperative and most use the indirect method because it’s easier to prepare and aligns with standard accounting practices.
However, the direct method can provide clearer visibility if you need detailed insight into cash movements.
| Activity | Source | Inflows | Outflows |
| Operating | Cash generated from day-to-day business operations. | Sales revenue, interest received, dividends received. | Payments to suppliers, employee salaries, rent, utilities, taxes. |
| Investing | Cash used for investments in assets. | Proceeds from the sale of assets and collection of loans. | Purchase of property, plant and equipment, or investments in other companies. |
| Financing | Cash from raising capital or repaying debt. | Proceeds from issuing stock or bonds, borrowing money. | Repayment of debt, payment of dividends. |
The direct and indirect methods are two approaches to preparing the cash flow statement, an important financial statement that summarises a company's cash flow over a specific period. Both methods focus on reporting cash flow from operating activities, but they differ in how they arrive at the final figure.
The direct method is best suited to businesses that want detailed, real-time visibility of cash movements.
The indirect method is more commonly used by growing businesses because it is simpler to prepare and aligns with existing financial reporting.
| Method | Advantages | Disadvantages |
| Direct | Greater transparency, easier for stakeholders to understand, provides detailed insights into operating cash flows. | More time-consuming to prepare, requires detailed transaction records, may not be feasible for all businesses. |
| Indirect | Easier and faster to prepare, aligns with accrual accounting, highlights the impact of non-cash items on cash flow. | Less transparent, may be harder for non-accountants to understand, doesn't show specific cash transactions. |
Most business owners don't make this choice because of an accounting preference; it's more about saving time and making better financial decisions.
The choice between the direct and indirect methods depends on various factors:
In practice, most growing businesses use the indirect method for reporting, while relying on forecasting and management tools for day-to-day cash visibility.
Whether you use the direct or indirect method, the cash flow statement is a powerful tool for assessing your company's financial health and making strategic decisions. By analysing cash flow patterns and engaging in cash flow forecasting, you can:
Understanding which cash flow method to use is only part of the picture. The real value comes from using financial information to make better decisions.
If you’re running a growing business and want clearer insight into your financial position, TAB can help you interpret your numbers and take a more strategic approach to cash flow management.
The direct method shows actual cash transactions, while the indirect method adjusts net income to calculate cash flow.
The indirect method is more commonly used due to its simplicity, but the direct method offers greater transparency.
Because it aligns with accrual accounting and is quicker to prepare.