Direct vs. indirect cash flow methods: Key differences explained

Your cash flow forecast is wrong. 

Not completely wrong—but wrong enough to cause problems. Maybe your short-term liquidity looks fine, but a sudden delay in receivables throws everything off. Or your long-term projections seem solid, yet somehow, you’re still scrambling to cover payroll. 

Most businesses think they have a handle on cash flow—until something unexpected throws everything off. A big customer pays late, suppliers demand early payments, or a sudden expense wipes out your buffer. That’s when you realize your forecasts aren’t as reliable as you thought. 

One reason? You’re probably looking at cash flow in only one way. Some companies track every euro moving in and out (direct method), while others focus on long-term trends based on accounting data (indirect method). The problem is, neither gives you the full picture on its own. Understating the difference between direct and indirect cash flow can make a big, well, difference. 

Let’s start from the basics: 

What is a cash flow statement?

A cash flow statement is a financial report that shows how money moves in and out of a business over a specific period. It shows exactly where a company’s money is coming from and where it’s going. It doesn’t deal with accounting tricks or paper profits—just real cash moving in and out. 

It’s split into three parts: 

1. Operating activities – Cash from the core business (customer payments, wages, supplier costs). 
2. Investing activities – Cash spent on or gained from assets (buying equipment, selling investments). 
3. Financing activities – Cash from funding (loans, stock sales, debt payments). 

These all play a critical part in forecasting because they show not just how much cash a business has, but when and how it moves. A company might look profitable on paper, but if cash isn’t coming in fast enough to cover expenses, it’s in trouble. 

When forecasting: 

• Operating cash flow helps predict whether the business can sustain itself without outside funding. 
• Investing cash flow shows how asset purchases or sales will impact liquidity. 
• Financing cash flow reveals how debt payments or new funding will affect future cash positions. 

Direct vs. indirect cash flow method: Understanding the difference 

Cash flow forecasting isn’t just about guessing how much cash a business will have. Sure, you might have a rough idea of how much cash your business has coming, but it’s hard enough to confidently say, for example, whether a profitable quarter actually means strong cash flow? 

Mixing up these two methods—or worse, relying on just one—leads to bad decisions. You might think you're in good shape based on your financial statements (indirect method), only to realize too late that cash isn’t arriving when you need it (direct method). Or maybe you’re laser-focused on short-term cash movements but have no idea whether your long-term strategy is sustainable. 

Understanding the difference can make the difference between staying ahead of cash flow problems and scrambling to fix them. Let’s take a look:

What is direct cash flow method? 

The direct cash flow method provides a real-time view of cash movements. When comparing direct vs. indirect cash flow, this method is best for short-term liquidity planning. 

How to set up a direct cash flow forecast: 

1. Gather cash inflows: 
   • Customer payments (accounts receivable).
   • Loan proceeds or financing inflows. 
   • Investment income (interest, dividends). 
2. Track cash outflows:
   •  Supplier and vendor payments (accounts payable). 
   • Payroll and benefits. Debt repayments and interest expenses. 
   • Capital expenditures (equipment, facilities). 
3. Calculate net cash flow: 
   • Sum total inflows and outflows over a specific period (daily, weekly, or monthly). 
4. Monitor and adjust: 
   • Compare forecasts to actual cash movements and adjust assumptions accordingly. 

Benefits of direct method

• Provides a clear, real-time view of actual cash inflows and outflows, making it highly accurate for short-term liquidity management. 
• Helps treasury teams monitor operational cash needs, ensuring the business can meet upcoming obligations like payroll and supplier payments.
• Enables precise cash pooling and working capital management in multi-entity businesses. 

Disadvantages of direct method 

• Requires detailed, high-frequency transaction data, which can be resource-intensive to collect and maintain. 
• More challenging to implement without integrated treasury management systems (TMS) or enterprise resource planning (ERP) tools. 
• Focuses on immediate cash movements but does not provide insight into longer-term financial sustainability. 

What is indirect cash flow method? 

The indirect method starts with net income and adjusts for non-cash items and working capital changes to estimate future cash positions. It’s primarily used for long-term forecasting, financial planning, and external reporting. 

How to set up an indirect cash flow forecast: 

1. Start with Net Income (from the income statement). 
2. Adjust for Non-Cash Expenses:
   • Add back depreciation and amortization. 
   • Adjust for deferred taxes and other non-cash items. 
3. Factor in working capital changes: 
   • Increase or decrease in accounts receivable (reflects customer payment timing). 
   • Changes in accounts payable (impact of supplier payments). 
   • Inventory fluctuations (cash tied up in stock). 
4. Include cash flows from investing and financing activities: 
   • Capital expenditures and asset sales. 
   • New debt issuance or repayments. 
   • Dividend payments. 
5. Project future cash positions: 
   • Extend the forecast over months or years to align with business strategy. 
     

Benefits of indirect method: 

• Aligns with financial reporting (income statement and balance sheet), making it easier to integrate with broader financial planning and analysis (FP&A). 
• Helps assess long-term cash flow trends, supporting debt planning, capital expenditures, and strategic decision-making.
• Provides a high-level view of cash generation from core business activities, independent of timing differences in cash receipts and payments. 
• Useful for meeting investor and lender expectations. 

Disadvantages of indirect method: 

• Lacks visibility into short-term liquidity, making it less effective for day-to-day cash management. 
• Relies on accounting adjustments and accrual-based figures, which may not always reflect actual cash availability. 
• Can mask underlying cash flow timing issues, increasing the risk of liquidity shortfalls if used in isolation.

Which method is most suitable for your business? 

When choosing between direct vs. indirect cash flow, the best approach is to use both. The direct method ensures cash is available for immediate needs, while the indirect method helps companies plan for the future. Together, they provide a full picture of a company’s financial health. 

Conclusion 

Your cash flow forecast is still wrong.  

Not as wrong as before—but wrong enough if you’re only looking at one side of the equation. Short-term liquidity can’t tell you if your long-term strategy is sustainable, and long-term projections won’t help when you’re short on cash next week. 

Using both direct and indirect cash flow methods for forecasting isn’t optional—it’s the only way to avoid surprises. Because in business, running out of cash isn’t just a forecasting mistake. It’s a failure you can’t afford.