Although preparing cash flow
statement with the help of indirect method is a complex approach as compared to
preparing it with direct method but almost 95 percent of firms prefer indirect
method to prepare cash flow statements as compared to the direct method. The reason behind using the indirect method to
prepare cash flow statement is that it shows a relationship between the other
two financial statements and these are the balance sheet and the income
statement. Another advantage of indirect method over direct method is that it avoids
duplication of effort of reconciling net income with cash flows from the
operating activities. The name also indicates that it operates indirectly from
the net income instead of starting from actual disbursement of cash and cash
receipts.
The major advantage of preparing
income statement with indirect method is that it helps in calculating the
liquidity and solvency of the firm and helps in measuring the ability of the
firm to change or transform its cash flows. The indirect method of cash flow
statement also helps us in analyzing other statements such as balance sheet and
income statement and hence it helps in examining the change in assets,
liabilities and equities of a firm. The indirect cash flow statements of two
different companies help in comparing the operating performance of the
companies. With the help of indirect cash flow statement we can measure the
timings of the future cash flows. In addition to that it also helps in
measuring the probability and the amount of future cash flows. Another benefit
of cash flow indirect statement is that it is less costly to convert net income
to net cash by operating activities. The method also highlights the difference
that actually exits between the reported profit and net cash flow using
operating activities.
