The direct cash flow method is the preferred way to prepare a cash flow statement, which includes operating, investment, and financial activities. Non-cash transactions may also be reported, and the statement helps businesses manage cash and report positive cash flow despite a net loss.
The direct cash flow method is a style of preparation for cash flow reporting. This statement is one of three important financial statements prepared and published by a company. With the direct cash flow method, businesses use actual receipts and other documents to show all cash flows within a business. The direct method is typically the preferred method for preparing your cash flow statement in compliance with accounting and government agencies.
The cash flow statement includes three sections: operating, investment and financial. Each section contains specific information from the company’s other financial statements. Operating activities include receipts from income and cash outflows related to expenses in a specific accounting period. Investing activities include income and payments from the sale and purchase of long-term assets. Financing activities refer to revenues from borrowing funds or the issuance of common stock and outflows incurred by repaying borrowed funds and paying dividends to investors.
With the direct cash flow method, each section—operating, investing, and financing—lists all cash inflows first, followed by cash outflows. A brief description provides information about the nature of the cash flow. At the bottom of the statement, the total for each section gives the total cash increase or decrease for the month. This total is then added to the opening balance on the cash flow statement; this balance represents the final balance of the previous month’s cash flow statement. The resulting total indicates the total cash generated for the entire accounting period, typically the current calendar year.
Some non-cash transactions may also be reported in the cash flow statement. The purpose of these items is to inform balance sheet users about other transactions that may involve liquidity in the future. The direct cash flow method allows for this information at the bottom of the statement. These transactions are typically referred to as non-cash investing and financing activities. Examples of these transactions include issuing a bond for a long-term business, obtaining a mortgage on a building, or similar transactions.
Reporting of cash flows on a separate statement is required when companies use the accrual accounting method. Ledger accounting records transactions as they occur, which does not account for the movement of cash in a business. Since most businesses use the accrual accounting method, the direct cash flow method helps businesses manage cash. Another reason for the cash flow statement is that companies can report a net loss for a year but still have positive cash flow. This occurs because some non-cash transactions – typically depreciation charges – do not involve cash, but negatively affect the income statement.
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