Cash flow is defined as the total amount of money transferred into and out of a business that affects the available liquid assets of a company. It also captures the results in the changes to the balance sheet.
Cash flow generally determines the short term capability of a company to pay bills and continue operations. Under cash flow under both methods, it requires the use of a reconciliation of net income to cash under the operating activities of a company that normally all corporations prepare.Under direct and indirect cash flow, there are no differences when it involves investing and financing activities. The main difference is when it comes to the operating cash flow which is generally stated in the first section of cash flow statement. (Weygandt, Kimmel, & Kieso, 2010).
Under the direct method, operating activities include lines of activity. Direct cash flow lists each major items of operating cash receipts as well as major items of operating cash payments. The cash payments are subtracted from cash receipts to determine net cash from operating activities.Examples of these are cash received from customers (cash payments) and cash paid to suppliers (cash paid for merchandise) that are activities affecting the balance sheet. (Weygandt, Kimmel, & Kieso, 2010).
The indirect method will show net income that is followed by adjustments. These adjustments need to be reconciled in order to find the total net income to cash from operating activities. The need to add or subtract (adjust) items to meet net cash from operating activities are shown in the statement of cash. Under indirect method, it does not report the inflow and outflow of cash from operating activities.This method only reports the necessary adjustments to reconcile net income to net cash used in operating activities.
The FASB currently allows both methods of direct and indirect as there is no difference (identical) in the reporting of cash flow. It indirect method is generally the method companies’ use that is easier and still requires full disclosure of cash activities. As there are other totals in other parts that contribute to cash flow, both methods were allowed as a determination of issues such as tax and interest which were adjustments needed on the cash flow statements.
