Format of the Cash Flow Statement:
Discussion of Direct and Indirect Formats
Since the Statement of Cash Flows is a relatively new edition to the Financial Statement set or reports, the methods and formats used for the reporting are just as new. In order to understand a little more about the statement itself, we need to understand the sources of input, and the reason for choosing one method over another.
First, let's examine the entities required to furnish a Statement of cash flows: every business enterprise and not-for-profit organization is required to present or produce a statement of cash flows.
In view of that fact, if you choose the direct method, you're going to have to also furnish a reconciliation statement with the Statement of Cash Flows that is in fact an additional indirect method or format statement. This simply adds to the time needed and the expertise needed to present the Statement of Cash Flows.
Next, is you are a small business you are required to furnish your lending institution with a set of Financials, a Statement of Cash Flows must be included and they will generally require that you use the indirect method.
And lastly, if you currently use the commercial software that can be purchased off the shelf to process your accounting transactions, such as QuickBooks or Peachtree Accounting, you will automatically be furnished the indirect format for the Statement of Cash Flows. Now, you do have the option to customize your report; however, if you're a small business owner utilizing commercial software, you're not that versed with customizing Financial Statement reporting.
Have you stopped to ponder why so much attention is given to just one section of the Statement of Cash Flows? The answer is a relatively simply one: cash transactions are very lucrative, they are the hardest to reconcile in the quest for accountability, and they are the most influential transactions of the business. Incorrect reporting can inflate totals in order to make it "appear" that the operating cash flow of the business is much better than in reality.
For these reasons, most accountants do not veer from the use of the indirect method; accountants generally must provide statements that attest to the validity of the information as furnished by the business and reconciliation is necessary as a way to provide a system of check and balance for accountant furnishing the reporting service.
Is there another reason for all the fuss about the indirect versus the direct method for reporting? The latest corporate scandals are a testament to the inability of accountants to always control the verification of data reported; however, the more information that is furnished to the investor or stockholder, and the more rigid the reporting process, the higher the probability that the information is accurate. The Sarbanes-Oxley legislature is the government's attempt at reforming some of the abuses that are occurring on a corporate level. The Financial Statements are a reflection of the financial health of a business, and would therefore be tremendously affected by new legislation and regulation. If the report formats in use are self-explanatory and show a direct relationship, the less likelihood there is for error and deception.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.