Direct method vs indirect method
Each, defined
Direct method
Direct method — Presenting operating cash flows as gross receipts and payments by major class — cash from customers, cash paid to suppliers and employees. Encouraged by ASC 230, but it must still be accompanied by the reconciliation from net income.
Indirect method
Indirect method — Presenting operating cash flows by starting from net income and adjusting for non-cash items and changes in working capital — the method most entities use. ASC 230 also calls it the reconciliation method.
Side by side
| Direct method | Indirect method | |
|---|---|---|
| Starts from | Cash receipts and payments | Net income |
| Status | Encouraged by ASC 230 | Permitted, near-universal |
| Operating cash flow | Same | Same |
Northwind's operating cash flow, walked from profit
Northwind's September 2026 operating cash flow is ($3,100) the indirect way and ($3,100) the direct way — the same figure, as it must be. Net income was $2,550; the difference is working capital. (Northwind Traders, Inc., September 2026, accrual basis, USD.)
| Indirect method | Amount |
|---|---|
| Net income | 2,550.00 |
| Depreciation | 500.00 |
| Increase in accounts receivable | (8,000.00) |
| Increase in inventory | (1,000.00) |
| Increase in prepaid insurance | (6,600.00) |
| Increase in accounts payable | 6,000.00 |
| Increase in accrued liabilities | 450.00 |
| Increase in deferred revenue | 3,000.00 |
| Operating cash flow | (3,100.00) |
How they relate
ASC 230 encourages the direct method and permits the indirect one; almost every company uses the indirect, and a company using the direct method must also present the indirect reconciliation.
The indirect method is more useful for explaining why profit and cash differ. The direct method is easier for a non-accountant to read.
Questions
- Do the methods change investing and financing?
- Only the operating section. Investing and financing are presented the same way under both.
- Which is more common?
- The indirect method: it falls out of the balance sheet and income statement without classifying every cash transaction.
Definitions are the glossary’s, generated from the same documents. Figures in the examples are computed by tested functions, not typed. General information for US companies under US GAAP, not accounting or tax advice.