“Cash is king” goes the saying. Even companies enjoying brisk business have been known to fail because of unhealthy cash flows. How can businesses best report on and manage the cash they receive and spend? International accounting standards bodies favour the use of the direct method (DM) in preparing cash flow reports. However, the accounting profession is split over DM’s benefits versus the indirect method (IM) which is used more often.
In a working paper entitled, "Are Direct Cash Flow Disclosures Informative? A Revisit", Singapore Management University accounting professors Yoonseok Zang and Steven Orpurt show conclusively that the direct method does better at predicting future performance and earnings based on a study of over 100 US-based companies which used direct cash flow statements.
A DM statement reports the source of operating cash inflows and outflows directly to facilitate assessment of an organisation’s risk. The format of a DM cash flow statement differs from the IM cash flow statement in that the DM statement directly reports individual cash flows from various operating activities, such as collections from customers, employee salaries or inventory purchases.
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