Direct Method
Candlefocus EditorThe direct method is seen as the most effective way of analyzing a company's cash flow. Unlike the indirect method, the direct method provides a better indication of a company’s source of cash and its utilization. The direct method itself is composed of two components – cash receipts and cash payments. Cash receipts, also known as inflows, are sources of cash including accounts receivables, donations, government subsidies, and equipment. Cash payments, or outflows, are payments for operating activities such as debt payments, payroll and rent. When the two components of cash flow from operating activities are combined, the user can determine the company’s net cash flow from operating activities.
The direct method is a popular alternative for analyzing a company’s cash flow. It reflects the current spending habits of a company and serves as a great reference when making decisions and investment initiatives. The direct method provides investors and stakeholders with concise and reliable details of a company’s cash situation.
The direct method of analyzing cash flow is more straightforward and accurate than the indirect method. This is because it lists all receipts and payments separately from each other. With the direct method, a clear picture of the cash flow can be seen as opposed to the indirect method which combines several accounting areas, resulting in a more complex reading. Additionally, the direct method can track the financial liquidity of a company, making is easier to prepare a company’s cash flow statement.
Overall, the direct method is the preferred method of analyzing a company’s cash flow position. It is widely used in the banking sector to accurately measure the cash flows of individual firms and helps businesses manage cash, pay bills and make investments in a timely and safe manner.