What Is a Cash Flow Statement? Direct vs Indirect Method

The cash flow statement answers the question every profitable company eventually asks: if we earned 9,400 €, why did the bank balance only rise by 1,300 €? It reports the actual movement of money over a period, classified by what the money was doing, and reconciles opening cash to closing cash.

It is the third of the three core statements, and the one that is hardest to argue with. Profit involves judgment — useful lives, provisions, cut-offs. Cash arrived or it didn't.

The three sections

Every cash movement falls into exactly one of three activities:

Operating — the trading itself: money received from customers, paid to suppliers and employees, VAT and income tax settled. This is the section that matters most. A business whose operating cash flow is persistently negative is consuming money to trade, and only financing keeps it alive.

Investing — buying and selling long-term assets: equipment, vehicles, software, investments. Negative investing cash flow is normal and often healthy; it means the company is building capacity.

Financing — dealings with the providers of capital: share capital paid in, loans drawn and repaid, dividends distributed.

The three net to the change in cash, and that change must reconcile:

Opening cash + operating + investing + financing = Closing cash

If it doesn't reconcile, the statement is wrong — the identity is not optional.

A worked example

The same company as in the income statement article — net profit 9,400 € for the year, in euros:

	Amount
Opening cash (1 January)	4,900
Operating activities	+9,300
Investing activities	−6,000
Financing activities	−2,000
Net change in cash	+1,300
Closing cash (31 December)	6,200

The closing figure is the same 6,200 € that appears as cash on the balance sheet — the two statements must agree, and this is the check that proves it.

Read across the sections: the trade generated 9,300 €, of which 6,000 € went into equipment and 2,000 € went out to lenders and owners. That is a company funding its own investment from operations — a different business entirely from one showing the same +1,300 € because operations lost 5,000 € and a new loan brought in 6,300 €.

Direct vs indirect method

The two methods differ only in how the operating section is built. Investing and financing are presented identically either way, and both methods produce exactly the same operating total.

Direct method

List the actual cash flows, gross:

Operating activities (direct)	Amount
Cash received from customers	177,400
Cash paid to suppliers	−106,500
Cash paid to employees	−52,000
Taxes paid	−9,600
Net cash from operating activities	+9,300

This is what a non-accountant expects a cash flow statement to look like, and it is genuinely more useful for operational questions — you can see collection performance and payment behaviour directly. The historical objection was effort: producing it by hand meant analysing every cash transaction by counterpart. That objection is a data problem, and data problems are what software is for.

Indirect method

Start from net profit and strip out everything that wasn't cash:

Operating activities (indirect)	Amount
Net profit	9,400
Add back: depreciation and amortization	+4,000
Increase in trade receivables	−2,600
Increase in inventory	−1,900
Increase in trade payables	+400
Net cash from operating activities	+9,300

Same 9,300 €, different route. The logic is mechanical:

• Non-cash expenses are added back. Depreciation reduced profit but no money left the company.
• An increase in receivables is subtracted. Revenue was recognized, the cash hasn't arrived yet.
• An increase in inventory is subtracted. Money went into stock that hasn't been sold.
• An increase in payables is added. Expenses were recognized, the cash hasn't left yet.

The indirect method is the more common in published statements, because it can be assembled entirely from two balance sheets and a P&L — no transaction-level analysis required. Its side benefit is that it shows why profit and cash diverged, which is exactly the question managers ask. Its cost is that the operating section becomes a reconciliation rather than a description: nowhere does it tell you how much customers actually paid.

IFRS and the EU Accounting Directive permit both; IAS 7 explicitly encourages the direct method while acknowledging that almost nobody uses it.

Which one to use

• Direct if you have transaction-level data and want an operational answer — how much cash customers actually paid, what actually went out to suppliers.
• Indirect if you need to match how analysts, banks and annual reports present it, or if you want the profit-to-cash bridge visible on the face of the statement.

Many companies produce the indirect method for the statutory accounts and read a direct-method report internally. That's not duplication; they answer different questions.

How Nordlet produces it

POST /v1/reports/cash-flow { fromDate, toDate } returns a direct-method statement. It finds every posted transaction that touched a cash or bank account in the period, takes the counterpart lines, and classifies each by its account code: non-current asset accounts (class 1) are investing, equity and long-term loan accounts (class 3 and group 40) are financing, everything else is operating. Rows are broken down by counterpart account, so you see which accounts the money moved between, and the report carries a balanced flag that verifies opening + net change = closing.

Two honest notes. First, the classification is by account-code prefix, so a company using a heavily customized chart of accounts should check the sections once before relying on them. Second, there is no indirect-method report — if you need the profit-to-cash reconciliation for statutory accounts, the inputs are available (net profit from /v1/reports/financial-statements, depreciation from the assets module, working-capital movements from two balance sheets) but the bridge itself is assembled outside the API today.

For groups, POST /v1/consolidation/report includes a consolidated cash flow: each member's statement translated at the closing rate and weighted by consolidation method, with equity-method associates excluded.

FAQ

What is the difference between the direct and indirect method?

Only the operating section. The direct method lists actual cash receipts and payments; the indirect method starts from net profit and adjusts for non-cash items and working-capital movements. Both produce the same operating cash total, and investing and financing sections are identical.

Which method do accounting standards require?

Neither is required — IFRS (IAS 7) and the EU Accounting Directive both permit either, with IAS 7 stating a preference for the direct method. In practice the indirect method dominates published financial statements because it is easier to prepare from summary data.

Why is depreciation added back in the indirect method?

Because it reduced profit without any money leaving the company — the cash left years earlier when the asset was bought (and appeared then in investing activities). Adding it back removes a non-cash charge from a statement that only cares about cash.

Can a profitable company have negative operating cash flow?

Yes, and it is one of the most reliable early warnings there is. Rapid growth funded by unpaid invoices and rising stock does exactly this: profit rises while cash drains. It is survivable while financing lasts and fatal when it doesn't.

Does the cash flow statement include VAT?

Yes — unlike the income statement, the cash flow statement deals in actual money, so VAT collected from customers and paid to suppliers flows through, and the net settlement with the tax authority appears in operating activities.