Cash flow statement: direct or indirect method to prepare cash flow

International Accounting  Standard - IAS 7 ,Direct or indirect method to prepare cash flow statement

Cash flow statement

IAS 7 describes how information is presented in a company's statement of cash flows for the period of cash and cash equivalents. Cash has cash and demand deposits in hand. Cash equivalents are short-term, high-liquidity investments that are easily converted to cash in known amounts and subject to a small risk of a change in value.

Methods to prepare cash flow statement

There are two methods to prepare statement of cash flow according to IAS 7

1. Direct method
2. Indirect method

Direct method

In direct method we disclose major classes of gross receipts and payments. In this method we deduct incurred expenses from revenue. After that we remove the non cash revenue and non cash expenses from them. The final amount termed as cash from operating activities.

Indirect method

• In indirect method, we start from profit and loss before tax and adjust it with the effect of
• changes in working capital like changes in inventories, receivable and payable.
• depreciation, unrealized gain or loss from foreign exchange.
• investing and financing activities.

Classification of cash flow according to their operations

The statement classifies cash flows as operating cash flow from 

1. Operating activities
2. Investment activities 
3. Financing activities

Operating activities

Operating  are the main income-generating activities of the company and other activities that are not investment or financing activities. A company reports cash flow from operating activities:

Direct method, in which the principal classes of gross cash receipts and gross cash payments are exposed; Or 

Adjusted indirect method of profit or loss for the effects of transactions of a cash-free nature, any deferral of past or future operating cash receipts or income items or expenses associated with investment or financing flows or acquisitions.

Investment activities

It include the acquisition and disposal of long-term assets and other investments that do not include cash equivalents. Total cash flows arising from acquiring and losing control over subsidiaries or other businesses are presented as investment activities.

Financing activities

Financing activities are activities that alter the size and structure of the entity's collaborative equity and debt.

Transactions and financing that do not require the use of cash or cash equivalents are excluded from the statement of cash flows but are disclosed separately. IAS 7 requires a company to disclose cash and cash equivalents and to reconcile the amounts in the statement of cash flows with the items specified in the statement of financial position.