The success of an organization greatly relies on the effectiveness of keeping appropriate records in the accounting and finance departments. A good and elaborate book of accounting enables the organization to identify a true and fair statement of its financial position.
One of the most significant books of accounting within an entity is the Statement of Cash flows. A cash flow statement is a financial document used by a company to track how their financial resources and acquired and utilized to enable them to keep up with the going concern concept of the firm.
An organization may utilize a direct or indirect method to prepare its statement of cash flow depending on the nature of its business. For example, organizations considered not-for-profit organizations majorly use the direct method to prepare their statement of cash flow. In contrast, profit-oriented utilize the indirect method of preparing statements of cash flow.
Tony Bell outlines that one of the easiest ways of determining whether a firm has used a direct or indirect approach to preparing a cash flow statement. He states that when the first section of the statement is Net Income or change in net assets, the method used is an indirect approach. In contrast, the direct approach portrays how an organization acquires its financial resources and how it is utilized.
One of the main advantages of utilizing the direct method to prepare a cash flow statement is that it provides detailed information on the company’s cash receipts and cash payments. The detailed financial statement enables the organization’s managers to make reliable decisions to achieve their goals.
A direct cash flow statement also makes it easier to predict the entity’s cash flow for effective assessment processes. The indirect approach is also advantageous since the cash flow is easy to prepare using spreadsheets, unlike the direct approach. A financial statement prepared using the indirect approach is also easily understandable as compared to direct cash flows.