What is the difference between the direct and indirect methods of cash flow reporting?

The correct answer highlights a fundamental distinction in how the two methods of cash flow reporting operate, specifically in the way they present cash flows from operating activities.

The direct method focuses on actual cash transactions. It presents cash receipts from customers and cash payments to suppliers and employees, thereby providing a clear view of cash inflows and outflows. This method offers a straightforward representation of the cash generated or used during the reporting period, making it easier for users of the financial statements to understand the cash position of the business.

In contrast, the indirect method begins with net income and then adjusts for non-cash transactions and changes in working capital. It reconciles net profit to cash flow from operations by adding back non-cash expenses (such as depreciation) and adjusting for gains or losses on sales of assets, as well as changes in current assets and liabilities. This method may be less intuitive for users trying to analyze cash flow, but it does provide a linkage between the income statement and the cash flow statement.

The other choices either misinterpret the methods or do not accurately reflect their core functionalities. For instance, while it’s true that the direct method may involve more reporting of actual cash flows, it doesn’t necessarily require more estimates compared to the indirect method. Thus,