The Indirect Method: How to Apply It to Your Business’s Cash Flow

by | Aug 27, 2021 | Insights To Business, Small Business Cash Flow, Working Capital

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There are two accounting methods that are used to create a cash flow statement. Both methods are valuable and give you an accurate depiction of your company’s cash flow and how well it is working. The accounting method you choose should be one that you are comfortable using. If you want to use the simpler of the two methods, you will want to use the indirect method. It works best when records are kept using an accrual basis. When the accrual method is used, it means that the sale is considered revenue even if the payment has not been cleared or even received by the bank.

Understanding How the Indirect Method Works

A cash flow statement showcases both the income and payments a company incurs on a daily basis. Cash flow statements are watched by individuals and companies who have a stake in the business. This can include investors, stakeholders, and other creditors who may have a vested interest in how well the business is doing financially. The cash flow statement offers valuable information on how cash is earned through the business’s activities and day-to-day operations.

Examples of the Indirect Method

Because revenue is recorded when it is earned and not when it is received, it can cause cash flow statements to be slightly off. The indirect method works to adjust those numbers convert the accrual method of accounting back to an actual cash method that shows the flow of cash in and out of the business. If a sale is made on credit, it would be recorded in the accounts receivable folder and sales would receive a credit. This causes the accounts receivable line to increase on the balance ledger. With indirect method accounting, the net income is at the top. The following lines represent adjustments to the asset and liability accounts. When all of the figures are tallied, the net income or sales will be determined.

Indirect Method vs Direct Method

There are three types of cash flow:

  • from operating activities
  • from investing activities
  • from financing activities

While the cash flows from financing and investing are the same in either of the methods, the cash flow from operating activities is recorded differently. Unlike when the accrual cash flows are presented in the indirect method, the direct method records actual flows of cash that go in and out during the business’s day-to-day operations. In general, most accountants prefer the indirect/accrual method because it is much easier and simpler to report on income statements and balance sheets. On the other hand, financial organizations prefer the direct method because it is more accurate and provides a more exact accounting of a company’s finances.

What Strategies Can Be Used to Maximize Income?

When it comes to managing your company’s finances, your first goal is to maximize your income without maximizing your taxes. Keeping your profits high and taxes low can be accomplished if you use the right strategies. Look for a financial management company that can help you make the most of your investments. The wiser your investment decisions, the better off your company will be when it comes to improving its overall earning potential.