The main difference between direct vs indirect cash flow is the method by which they are calculated. This could be the direct cash flow method or the indirect cash flow method. These two accounting processes yield the same informational results including:

1. Operating cash flow: money produced by your business operations, services, or product sales
2. Investing cash flow: money generated by assets, such as investments
3. Financing cash flow: money injected into the business by investors, the owner or bank loans

Business owners in Canada keep tabs on the financial health of their businesses by preparing cash flow statements periodically for review. This lets them see at a glance where money is coming into the business, and how it's being used or spent, over a set period of time.

Table of Contents

1. What is the direct cash flow method?

2. What is the indirect cash flow method?

3. What are the benefits of direct vs indirect cash flow?

4. Understanding IFRS and GAAP standards for cash flow statements

5. FAQ

What is the direct cash flow method?

The direct cash flow method is the easiest and most direct way to create a cash flow statement. It looks at money flowing into and out of the business as the transactions are happening.

For example, money comes into the business from customer purchases and dividends on business investments. Money exits the business through payments made to employees, suppliers, and income tax obligations.

When do I use the direct cash flow method?

As a business owner, you can choose to use this method whenever you like. It provides a quick snapshot of where your business is sitting on any given day of the month.

The direct cash flow method can help you plan for the weeks ahead. Perhaps an increase in outflows (expenses) and a decrease in inflows (income) means cutting back on employee hours or offering a sale to boost consumer traffic and purchasing.

How to calculate cash flow using the direct method

To calculate your business cash flow using the direct method, create two columns on a sheet of paper:

• Label one inflows — and list each way money comes into your business (and the amount) for a set period, such as the current month-to-date. The inflows column will generate a positive number when added together.
• A few examples of inflows for a small business include payments from customers, small business loan funds, donations received, or tips from customers.
• In the second column, itemize all the outflows and their dollar amounts. The outflows column will add up to a negative number because it represents money flowing out of the business.
• A few examples of outflows for a small business include payroll for employees, payments to contractors, the owner's salary, inventory/supplies purchasing, and brick-and-mortar location costs (rent/mortgage, utilities, upkeep, and so on).

Subtract the outflows from the inflows, and you will see your net cash for the period you determined.

Ideally this number is positive, which means your business is making money.

However, start-ups often operate in the negative (using financing from small business loans or a line of credit for essential expenses) until their operations gain momentum.

You can further parse the results by making an inflow and outflow itemized list for each of the three categories mentioned earlier:

• operating
• investing
• financing

This gives you more a more detailed view of where your money is flowing — also known as your cash flow.

You can also use accounting solutions like QuickBooks to quickly calculate your cash flow reporting. It allows you to easily use the direct cash flow accounting method to see your inflow and outflow at a glance. Simply choose the time period you wish to review (such as a week, month, or year) and generate the report in just a few clicks.

What is the indirect cash flow method?

The indirect cash flow method is much more complicated to use and shifts from the accrual method (used in the direct cash flow method) to the cash method of accounting when specifically looking at operating costs.

The indirect cash flow method can look at financial changes from one period to another (such as year-over-year), rather than within a defined period — such as one month.

When do I use the indirect cash flow method?

The indirect cash flow method is preferred by accountants.

It's helpful for those who need to see more details, like amortization schedules (losses and gains) for large equipment purchases that depreciate over a few years.

How to calculate cash flow using the indirect method

It's best to consult with an accountant or financial professional to generate a cash flow statement using the indirect method.

To calculate cash flow using the indirect method, you'll need to provide a balance sheet and an income statement. You will also need to know your net income and all non-cash items that have financial value (non-cash working capital), the dates purchased, and the value of these items.

What are the pros and cons of direct vs indirect cash flow?

As a business owner, it's smart to monitor your cash flow periodically. Selecting which method works best for you is an individual choice.

Here are a few pros and cons to consider:

Direct cash flow method

Pros:

• Easy to use (and available through QuickBooks)
• Simple to understand the reports
• Ability to spot trends in cash flow

Cons:

• Less detailed than an indirect cash flow report
• Shows a smaller scope of the business operations
• May miss possible business deductions

Indirect cash flow method

Pros:

• More detailed than direct cash flow reports
• Gives a broader view of the overall business
• Shows information your accountant likes to see
• May help identify more business deductions

Cons:

• Can be complicated to create
• May require hiring an accountant
• Can be more time-consuming than the direct cash flow method

Understanding IFRS and GAAP standards for cash flow statements

As a business owner, producing a cash flow statement (using either method detailed earlier) following the International Financial Reporting Standards (IFRS) or the Generally Accepted Accounting Principles (GAAP) is required in Canada.

For the IFRS, interest and dividends can be itemized under investing, financing, or operating income.

For the GAAP, interest and dividends must be reflected on the income statement as a cash flow from operations (not financing or investing).

Ready for a simpler way to manage your cash flow? QuickBooks offers real-time reporting on everything from income statements and balance sheets, to cash flow reporting and profit/loss statements. Find out more about how QuickBooks can help manage your cash flow reporting, so you can watch your business grow.