What is the Cash Flow Statement Direct Method?

The direct method of presenting the statement of cash flows presents the specific cash flows associated with items that affect cash flow. Items that typically do so include:

Cash collected from customers
Interest and dividends received
Cash paid to employees
Cash paid to suppliers
Interest paid
Income taxes paid

The advantage of the direct method over the indirect method is that it reveals operating cash receipts and payments.

Disadvantages of the Cash Flow Statement Direct Method

The standard-setting bodies encourage the use of the direct method, but it is rarely used for the following reasons:

Data collection difficulty. The information required for the direct method is difficult to assemble; companies simply do not collect and store information in the manner required for this format. Instead, they use the indirect method, which can be more easily derived from existing accounting reports.
Restructuring cost. Using the direct method may require that the chart of accounts be restructured in order to collect different types of information.
Comparison effort. If the chart of accounts is restructured to accommodate the data collection required for the direct method, the reporting entity will somehow have to manually devise the direct method reporting for any prior comparison periods included in its financial statements, which could be quite difficult.

Related AccountingTools Courses

The Interpretation of Financial Statements

The Statement of Cash Flows

Example of the Statement of Cash Flows Direct Method

Lowry Locomotion constructs the following statement of cash flows using the direct method:

Lowry Locomotion
Statement of Cash Flows
for the year ended 12/31/x1

FAQs

How does the direct method differ from the indirect method?

The direct method reports actual cash receipts and cash payments from operating activities, such as cash collected from customers and cash paid to suppliers. The indirect method starts with net income and adjusts it for noncash items and changes in working capital to arrive at operating cash flow. As a result, the direct method emphasizes cash transaction detail, while the indirect method emphasizes reconciliation from accrual-based earnings.

Cash Flow Statement - Indirect Method

Cash Flow Statement Template

Statement of Cash Flows Overview

The Difference Between Direct and Indirect Cash Flow Statements