Direct vs Indirect Cash Flow: Which is the Right Fit for Your Business?

It’s no secret that cash flow management can make or break a business. In fact, cash flow challenges are one of the top reasons businesses fail, but you don’t need to be one of them.

The key is to cultivate deep insights into how money moves in and out of your business. For this, you need serious financial reporting—a key part of that is cash flow statements.

These statements give you the insight you need to:

• Apply for loans
• Plan growth
• Meet IRAS compliance

There are two main methods to prepare a cash flow statement, direct and indirect cash flow. Each offering a different view of your financial health.

Understanding cash flow statements in Singapore

Before we dive into direct and. indirect cash flow statements, let’s cover the basics. A cash flow statement shows how money moves in and out of your business, It’s one of the most important tools you have, right alongside the balance sheet and income statement.

Usually, it’s divided into three sections: 

• Operating activities: Day-to-day transactions like sales and supplier payments 
• Investing activities: The purchase or sale of assets
• Financing activities: Loans, dividends, and equity injections

Together, these sections should paint a clear picture of your business’ cash position, and tell you whether you’ll be able to keep the business running. 

However, it goes beyond internal management. Preparing cash flow statements is essential for compliance with the Singapore Financial Reporting Standard (SFRS) 7. This is the standard that outlines exactly how companies should disclose cash flow information.

The direct method: Transparent but data-intensive

For many businesses, making a cash flow statement by the direct method is favored as it’s quick and relatively simple.

What is the direct method?

The direct method of cash flow reporting presents a clear and detailed list of actual cash inflows and outflows from a business’ operating activities. It doesn’t adjust net profit, instead, it simply records cash transactions. Those might include cash received from customers, payments to suppliers, employee wages, and utility bills.

What this creates is a real-time snapshot of cash movement in your business.

While the direct method is straightforward, it still requires meticulous tracking of every cash transaction during the reporting period.

Advantages of the direct method

There are a few areas in which the direct method really stands out, including:

• Transparency: You get an immediate picture of exactly how cash flows through the business.
• Clarity: Direct cash flow statements tend to be clearer, which makes them particularly useful for those not familiar with accounting jargon, like investors.
• Easier to manage: For smaller businesses, direct statements are easier to manage and align with actual operations.
• Actionable insights: They provide clear insights that business owners can use to make decisions on spending and costing. 

Disadvantages of the direct method

Just because the direct method is simple and easy to implement, doesn’t mean you should overlook its drawbacks. Those include:

• Time-consuming and labor-intensive: It still takes time and expertise to gather and calculate the figures correctly. Don’t forget, every cash transaction must be tracked and categorized individually, which can significantly increase the administrative workload. That’s especially true if you have high transaction volumes.
• Requires detail: The direct method actually requires more detailed recordkeeping than the indirect method, as companies need to extract cash-based data directly from their accounting systems. That might not be readily available if you operate on an accrual basis.
• Not suitable for larger firms: Larger companies often opt for the indirect method due to its compatibility with accrual accounting and financial reporting practices. If you rely heavily on accounting software or have more complex financial structures in place, the direct method may not be for you.

The indirect method: Widely used and easier to prepare

If those drawbacks give you pause, don’t worry, the direct method isn’t your only option. In fact, many businesses prefer using the indirect method for their cash flow statements. 

What is the indirect method?

The goal of the indirect method is more or less the same as the direct method, to tell you how cash flows through your business. However, it goes a step further and takes extra elements into account.

It begins with net profit from the income statement and then makes adjustments for non-cash items, such as:

• Depreciation
• Amortization
• Gains or losses on asset sales

It also adjusts for changes in working capital, like:

• Accounts receivable
• Accounts payable
• Inventory levels

This adds up to a more detailed picture that reconciles your accounting profit with your actual cash movement. Essentially, it helps explain where profit does or doesn’t turn into actual cash.

Advantages of the indirect method

There’s a reason Singaporean SMEs generally favor the indirect method, advantages include:

• Quick and easy preparation: Although the indirect method takes more figures into account, it doesn’t need to be a headache to use it. With modern accounting software like QuickBooks, which tracks accrual-based data, the indirect method can be a practical choice for time-strapped SMEs.
• Accrual accounting alignment: If you’re operating a service on a subscription basis, you might find that the indirect method works better because it takes unrealized cash into account. That’s why it’s often preferred by banks and investors, who are accustomed to seeing reports structured this way.
• Clear connection between net profit and cash flow: This method offers insights into how changes in working capital affect liquidity, which the direct method doesn’t. That can be handy when analyzing the cash impact of accounting decisions.

Disadvantages of the indirect method

No process is without its flaws. Just like the direct method, the indirect method has drawbacks that could be deal-breakers for certain business owners.

These include:

• Less transparent: Since it doesn’t show specific cash transactions, non-financial readers may find it harder to interpret and use. That could become a problem when it comes to transparency with stakeholders and investors.
• Not completely reflective: The indirect method doesn’t focus so much on actual inflows and outflows, but rather on adjustments. Some say this obscures the true nature of operational cash movements, which, in turn, can make realistic short-term cash planning tricky.
• Learning curve: With the indirect method, you’ll need an understanding of non-cash adjustments and working capital changes. For SMEs, that could mean long, costly training. 

Comparing direct vs indirect cash flow methods

Both the direct and indirect cash flow methods show net cash flow from operating activities, but the choice isn’t arbitrary. You should take the time to choose the right method for your business, as they differ greatly in terms of:

• How they present information
• The effort required to prepare them
• Their usefulness for various audiences

It all comes down to your needs and available resources. 

With that in mind, here’s a side-by-side comparison of indirect cash flow and direct cash flow methods:

And here’s a breakdown of which types of businesses use each method:

• Startups and SaaS companies: Many favor the indirect method because it’s compatible with accrual-based accounting and investor expectations. Plus, it’s easier to automate through cloud-based platforms like QuickBooks.
• Retailers and Food & Beverage outlets: These businesses may benefit from the direct method. When you have high volumes of cash transactions, the direct method can help track day-to-day sales and expenses more granularly.
• Service providers and freelancers: If your operations are relatively simple, the direct method may be preferable. However, if you’re handling larger volumes and need to align with lenders or long-term reporting needs, many prefer the indirect method.
• Growing SMEs with external funding: The indirect method is preferable as it aligns with accounting standards and is usually favored by banks. It also provides a strong link between profitability and liquidity.

How to choose the right method for your Singapore business

Still weighing up the direct method for cash flow against the indirect method? 

You shouldn’t rely on gut feeling alone. There are multiple factors you need to take into account, including:

• Business complexity and cash volume: If you handle high volumes of cash transactions every day, you may prefer the direct method, as it shows actual cash movement. On the other hand, businesses with fewer transactions but complex financial activities may prefer the indirect method.
• Financial systems and software: If you’re already using advanced accounting software like QuickBooks, the indirect method is easier and quicker. That’s because QuickBooks lets you automatically generate cash flow statements from existing reports. The direct method is generally more manual.
• Stakeholder expectations: Are you regularly dealing with banks and investors? If so, the indirect method could be better as it aligns with accrual accounting and is more widely accepted for formal reporting.
• Reporting obligations: For companies applying for government grants or tax incentives, the indirect method provides a smoother reporting process and supports long-term financial planning more efficiently.

Let’s clear things up with a few example scenarios:

• Retail SME ( a boutique store or bakery): This company handles a lot of cash sales and purchases. Here, we’d say the direct method offers better insight into daily cash flow. This will help with inventory management and supply chains.
• B2B services firm (a marketing agency): Here, the business issues invoices on credit terms and tracks project-based revenue. For them, the indirect method is more efficient. It aligns with how income and expenses are recognized, not just paid.
• Tech startups (SaaS provider): This company is focused on growth, with investors and grant reporting needs. They chose the indirect method because it offers better alignment with financial planning and long-term forecasting.

Implementing your chosen method with QuickBooks

The good news is that whichever cash flow statement method you need, QuickBooks makes the process easier. You can easily generate and customize reports to fit your business needs, thanks to smart, built-in automation. 

QuickBooks Online in Singapore uses the indirect method by default, however, it doesn’t end there. You can tailor your cash flow reports to highlight the details most relevant to your business.

Here’s how to customize cash flow reports so they work for you, every time:

1. Go to Reports in the left menu.

2. Search for Statement of Cash Flows.

3. Click Customize to filter by date range, account type, or specific customers/suppliers.

4. Use the “Group by” and “Display columns by” features to tailor the view.

If you’re after more direct-style insights, you can generate transaction-level reports and easily organize them into a cash flow-friendly format.

So, what about exporting cash flow statements for the people who need to see them? With QuickBooks, it couldn’t be easier:

5. Click Export to Excel or PDF to share.

We know that manually creating cash flow reports takes time and patience, that’s why QuickBooks has extensive automation capabilities designed to get things moving in a fraction of the time.

So, if you want to set up recurring entries, simply:

1. Go to Gear Icon > Recurring Transactions.
2. Click New, choose the transaction type, and set frequency.
3. This ensures accurate and consistent data for cash flow reports.

Don’t forget, our Learn & Support section is packed with handy guides on everything from cash flow reporting to automation, so make sure to check it out.

Conclusion: Clarity today for better cash flow tomorrow

According to SFRS in Singapore, both the direct and indirect cash flow methods are acceptable. So whichever you choose, as long as you prepare it correctly, you’re on the right track.

However, that doesn’t mean they’re the same. The direct method offers greater visibility into actual cash movements, while the indirect method is easier to prepare and aligns with most accounting systems. 

What really matters is selecting the method that supplies the kind of clarity you need to make smart financial decisions. 

Once you’ve chosen, use QuickBooks to speed up and optimize the process. With our software behind you, you can manage your cash flow confidently and efficiently. Try it for free today!