The money that comes into your business and the money that goes out is called cash flow. Understanding cash flow is essential to managing your finances and protecting your business. There are two methods of cash flow: direct and indirect.
Direct cash flow includes revenue, expenditures, or other payments made in the normal course of doing business. Indirect cash flow is any expense that relates to a cost incurred in the past or which could be incurred in the future. Direct expenses include things like payroll costs and rent, while indirect expenses could include equipment-related costs such as insurance or depreciation, as well as sales which are still in accounts receivable. Chances are, if you are in business you use both direct and indirect cash flow to report your net income and help you make decisions about your business.
In this article, you’ll find the answers to the following questions:
What is direct cash flow?
Direct cash flow is the money that flows directly into and out of your business. For example, if you’re a plumber with specific hours for appointments, it would be considered direct cash flow if you invoice someone for a service after completing it. This is because the money flowed directly into your account when you completed the job. Direct cash flow factors in cash payments and receipts and does not begin its calculations from a company’s net income. As a result it calculates only what has been received, for a certain period, after outgoings have been deducted, also known as the income statement method. A complexity of the direct cash flow method is that the FASB requires disclosure of the reconciliation of net income to the cash flow from operating activities, which would have been reported if the indirect method had been used to prepare the statement (Investopedia, 2020).
What is indirect cash flow?
Indirect expenses include equipment-related costs such as insurance or depreciation. For example, the finance department may need to purchase new office furniture for an upcoming holiday party. The company will not incur this cost until December, but it needs to cover the expense now so that it can plan effectively and budget appropriately. Indirect cash flow takes the net income the company generated in a period and adds or subtracts any changes in assets and liabilities accounts resulting in an implied cash flow. As such, it is closely monitored by investors, creditors and other stakeholders. Accounting using the indirect cash flow method involves reporting income for the period it was earned, rather than when it was received.
Why do you need both types of cash flow?
Both types of cash flow are important for different reasons. Direct cash flow is important because it represents the money that comes into your business and is used to operate day-to-day. Indirect cash flow, on the other hand, is important because it tells you about expenses that could be incurred in the future. For example, you’re renting an office space for $2,000 per month. You know that this expense will go away at some point in the future, but you don’t know when. Your indirect cash flow reflects this uncertainty in timing by showing as a long-term liability on your balance sheet.
The value of both direct and indirect cash flow is that they allow you to gauge your company’s financial health and make decisions accordingly. The downside to these types of cash flow is that they can be misleading if not managed properly or calculated correctly.
How to keep track of your direct and indirect cash flows
When you’re trying to manage your finances, it can be difficult to keep track of direct and indirect expenses. A good way to do this is to use a cash flow statement. This will tell you what money came in and what money went out for the past month or year. Using software to help you manage your incoming and outgoing cash flow can assist you in managing your direct and indirect expenses and ensure your accounting is accurate. Synder is a software that can assist you with this, providing you with multiple reports within a few clicks! If you run an e-commerce business, Synder has the ability to synchronize your online sales platforms as well as so many other features. By utilizing an accounting software such as Synder, it takes the stress of maintaining accurate records, invoicing, receipts for expenses and other incoming and outgoing payments in your business and manages it all for you!
When you’re trying to understand cash flow, it’s important to know the difference between direct and indirect cash flows. Direct cash flow is important because it helps you gauge how your product or service sales are going, reporting on cash payments and receipts across your business. Indirect cash flow is essential because it helps you pay your bills and cover your overhead, it involves asset and liability changes which are adjusted to the net income. Automated accounting software such as Synder helps you to work smarter, not harder. By automating otherwise tedious manual tasks, you free yourself up to focus on growing your business. And if you were paying someone else to do this aspect of bookkeeping for your business you will be saving money too! Synder gives you the ability to instantly analyze and generate various reports tailored to your business, including cash flow statements!