The most important difference between the direct method and the indirect method involves the cash flows from operating activities. The differences can found in the first section of the statement of cash flows. There is no difference in the cash flows reported in the investing and financing activities sections.
When using the Direct Method, one should list cash flows in the operations section of the cash flow statement. Under this method, the cash flows from operating activities will include the amounts for lines such as cash from customers and cash paid to suppliers, employees and others. The same section also reports cash paid for income tax and interest. The problem in trying to use the direct method is that a company might not keep the information in the required form. For instance, companies using accrual accounting may group together cash and credit sales, in which case, they would have to make special stipulations to track cash sales separately. The direct method must also provide a reconciliation of net income to the cash provided by operating activities.
When using the Indirect Method, one should adjust net income to transform it from an accrual to a cash basis. However, this will require one to add back non-cash expenses. Categories included in non-cash expenses may include depreciation, amortization, loss provision for accounts receivable and any losses on the sale of a fixed asset. In addition, one will need to adjust net income for changes between the starting and ending account balances in current assets, and should remember to exclude cash and current liabilities for the period. These accounts include accounts receivable, inventory, supplies, prepaid assets, payable liabilities and unearned revenues. The indirect method automatically provides a reconciliation of net income to the cash provided by operating activities. The main