Preparation of cash flows involves a direct and indirect method of cash flows. Companies in the United States have to either use the direct or indirect method of preparation of cash flows. Most large U.S. corporations make use of the indirect method. SCQ Corporation needs to prepare its cash flow statement for the years 2009 and 2010. The preparation of cash flows involves three activities that include operating, investing, and financing. The use of the direct and indirect method of preparing the cash flows will provide an overview of the company’s cash flow.
Indirect Method Cash Flow
Indirect Method Statement of Cash FlowsSCQ Corporation For Period Ending 12/31/2010 |
|
| Cash flows from operations | |
| Net income | $115 |
| Add depreciation | $100 |
| Add the decrease in accounts receivable | $(200) |
| Deduct the increase in inventory | $(250) |
| Deduct the decrease in accounts payable | $100 |
| Add the taxes payable | $100 |
| Add the deferred taxes | $15 |
| Net cash flows from operating activities | $(20) |
| Cash flows from investing | |
| Purchasing of equipment | $(100) |
| Net cash flows from investing activities | $(100) |
| Cash flows from financing | |
| Notes payable | $30 |
| Issuing of common stock | $140 |
| Net cash flow from financing | $170 |
| Net Cashflow | $50 |
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Direct Method Cash Flow
Indirect Method Statement of Cash FlowsSCQ Corporation For Period Ending 12/31/2010 |
|
| Cash flows from operations | |
| Cash from customers | $930 |
| Cash paid to employees and vendors | $(950) |
| Net cash flow from operating activities | $(20) |
| Cash flows from investing | |
| Purchasing of equipment | $(100) |
| Net cash flows from investing | $(100) |
| Cash flows from financing | |
| Note payable | $30 |
| Common stock | $140 |
| Net cash flows from financing activities | $170 |
| Net cash flow for the entire period | $50 |
Differences Between Direct and Indirect Methods
The main difference between the direct and indirect methods of cash flow statements is in operating activities. There are no differences between the two methods of cash flow in investing and financing activities. The indirect method of cash flows begins with the analysis of a company’s net income. It is then followed by adding the depreciation expense, adding the decrease in the accounts receivable, deducting the increased inventory, deducting the decreased accounts payable, and finally adding the increased accrued expenses payable. The direct method of presenting cash flows does not use net income as the starting point. Instead, it uses cash from customers, cash paid to employees, cash paid to vendors, and cash paid for the interest.
The indirect method uses net income as the base and makes the necessary adjustments through addition and subtractions. The calculations convert the total net income to the actual total cash from the operations. The direct method involves cash from customers, those paid to suppliers, employees, and other stakeholders. The direct method starts with cash transactions such as the cash that has been received and the cash that has been paid and ignores the non-cash transactions. Therefore, the direct method is more detailed about the information in the operating cash flow but can be sometimes time-consuming. The time and difficulty required to list the receipts and the cash disbursements through the direct method make the indirect method most preferred and common.
