Direct or indirect method for operating cash flows
Whether a client's operating cash flows should use the direct or indirect method under IAS 7, what each needs from the records, and where tax paid goes.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
Many small-company cash flow statements start from profit and work back to cash. Few show the receipts from customers and the payments to suppliers that a bank manager would actually like to see. Is that a choice, a habit or a limit of the records? IAS 7 allows both approaches, and the right one depends on what the client's records can support.
What IAS 7 allows
Under IAS 7, an entity reports cash flows from operating activities using either:
- the direct method, which discloses major classes of gross cash receipts and gross cash payments; or
- the indirect method, which adjusts profit or loss for the effects of non-cash transactions, deferrals or accruals, and items of income or expense associated with investing or financing cash flows.
ACCA puts it simply: the direct method shows actual receipts from customers and payments to suppliers and employees, while the indirect method reconciles operating profit to cash from operations. Investopedia likewise notes that there are two methods of preparing cash flows, the direct and the indirect. The choice concerns the operating section only.
A change to the indirect method's starting point is worth knowing about. ACCA's article is marked as relevant from September 2025, and the IFRS Foundation's IAS 7 page states that IFRS 18 amended IAS 7 to require the operating profit or loss subtotal as the starting point for the indirect method. Check which version of the requirements applies to the client's reporting period.
What each method needs from the records
Direct method
The direct method needs the client's cash movements analysed by type: cash from customers, cash to suppliers, cash to employees and so on. For a client that codes its bank account transaction by transaction, that is achievable. For one whose ledger runs receipts and payments through suspense accounts, it means rebuilding the analysis from the bank statements.
Indirect method
The indirect method needs profit, the movements in working capital such as receivables, payables and inventories, the non-cash items such as depreciation and provisions, and the items that belong in investing or financing. All of that is in the trial balance and the comparative balances. That is why so many small clients use it: the records they already keep are enough.
A worked example in words: a retailer's profit includes depreciation on its shopfitting, an increase in stock and a fall in trade payables. The indirect method starts from operating profit, adds back the depreciation, deducts the increase in stock because cash went into it, and deducts the fall in payables because cash went out to settle them. The direct method would instead show the cash received from sales and the cash paid to suppliers and staff, read from the bank.
Tax paid sits in operating cash flows under both
ACCA explains that under both the direct and the indirect methods, income taxes paid are presented as a cash outflow from operating activities. The figure is the cash actually paid to SARS, the NRS or KRA during the year, including provisional payments, instalments and settlements of earlier years, not the tax charge in profit or loss.
A simple check: the opening tax liability plus the year's charge, less the closing liability, should equal the tax paid. If it does not, look for an overpayment carried as an asset, or a refund received during the year. The classification of other lines, such as interest, dividends and lease payments, is discussed in classifying cash flows.
How Achekam derives the current-year column
In Achekam's Financials Studio, the draft set is built from the mapped trial balance with every figure calculated in code, including the four primary statements. The cash flow statement's current-year column is worked out from the change in balances, and staff can type their own figure for any line, which then takes priority. Comparatives can come from a person's figures, last year's issued statements or a prior-year set a person reviews.
Deriving the column from balance movements gives a starting point consistent with the statement of financial position. It also means the figures are only as good as the classification of the balances behind them. A non-cash movement, such as an asset bought with a loan or a dividend declared but unpaid, can appear as a cash flow unless someone adjusts it. Review each line and type over any that is wrong.
Before promising a client a direct-method presentation, check the layout the Studio produces for that set; where a line needs a different figure from the derived one, typing it in is the route. The step-by-step logic of the indirect reconciliation is in the indirect method from profit to cash.
Client books produce no cash flow statement
Where the client keeps its own books on Achekam, those books do not produce a cash flow statement. The cash flow statement in the annual set comes from the Studio, built from the trial balance the firm maps, not from the client's ledger.
Plan for this when agreeing the timetable. The cash flow statement exists only once the year-end trial balance has been mapped and the draft built, so a client who wants it early for a lender needs the year-end close done early too.
Choosing, in short
- Use the indirect method when the records support balances and profit but not a clean analysis of cash.
- Offer the direct method when the client codes its bank transactions well, or when a lender or funder asks to see receipts and payments.
- Either way, tax paid sits in operating activities, and the derived figures need a person's review.
ACCA's technical article on cash flow statements explains, from first principles, how to calculate cash flows and where they are presented in the statement of cash flows.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
