What are the major advantages of the indirect method of reporting cash flows from operating activities?
According to an article by Bassam M. Abu-Abbas of Princess Sumaya University for Technology in Amman, Jordan, some of the major advantages of reporting cash flows from operating activities using the indirect method, instead of the direct method, are that:
- direct cash flows can be derived from information in indirect reports (making direct cash flow reporting redundant);
- the indirect method of reporting cash flows is more cost effective and easier to put together than the direct method;
- an indirect cash flow report is easier for creditors and investors to make use of in decision making;
- indirect cash flow reports provide a clearer understanding of the "lead and lag between cash flows and income information" since net income is reconciled to net cash flows from operating activities in the indirect reporting method (while the direct method reports "gross inflows and outflows components of cash flows from operations") (Abu-Abbas).
"Direct, Indirect, or Both Methods of Reporting Operating Statement of Cash Flows" by Bassam M. Abu-Abbas, Princess Sumaya University for Technology, Amman, Jordan, published in International Journal of Finance and Accounting, SAP, 2014.
In regards to operating activities a company’s cash flow statement provides a view of a company’s cash position from its primary business operations. A stable or growing operational cash flow is an indication of good financial health and secure long term prospects. The indirect method uses accrual accounting to record expenses and revenue, this method records a transaction at the time they occur rather than at the exchange of cash. The primary advantages of the indirect method are:
- It is less complex to use for reporting purposes
- It provides a better view of business activity
- Information is more up to date and available
- Balanced cash income
- It shows combined financial statements
- Reveals non-cash organizational transactions
- It is an Industry standard used by most organizations