The Statement of Cash Flows is a critically important financial report. Many accounting and bookkeeping professionals overlook, or ignore this statement. I suspect, it’s because they really don’t understand it, or they don’t appreciate the importance of what it tells us, or they don’t know how to explain it well to their clients.
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I’ll be honest, I was very excited when I saw this critically important financial report had been added, until I took a closer look.
Xero is using the “Direct Method.” Most of us in accounting and finance are accustomed to seeing the Statement of Cash Flows using the indirect method. In my opinion, the indirect method provides much more useful information.
If our goal, as accounting and bookkeeping professionals is to become the more strategic advisor, then I need better information. The Indirect Method of preparing the Statement of Cash Flows gives me that.
A Statement of cash flows prepared in the indirect method should reconcile accrual basis net income to your cash balance at the end of a specified period. See my video on Understanding the Statement of Cash Flows in QuickBooks. This provides valuable insights into how the company is surviving. Are we able to function off of our operating profits, or are we funneling money into the business with loans and investments to keep afloat? A business can only survive so long this way. Eventually the investments and loans must prove to be useful in helping the business turn a profit, so it can survive on it’s own operating profits.
Xero’s Direct Method statement of cash flows takes the concept a little too literally. It just shows cash flows. For example, instead of showing the change in accounts receivable, it shows only payments received from customers. Instead of showing the change in accounts payable, it shows only payments made to suppliers and employees. When I look at this, I feel like I am missing a really important piece of the puzzle. I may have received $25K from customers in the period, but I may also have increased my accounts receivable by $100K. This information helps me see what I can expect about the future cash flows. The direct method of preparing the Statement of Cash Flows leaves out this important piece of the puzzle. As my clients most trusted, strategic advisor this means I need to do extra analysis to give my client what they need.
If you google Statement of Cash Flows, you will find a number of examples of what the statement of cash flows should look like, and then you will begin to see the difference from what Xero has provided. Search the Direct Method, and then search the indirect method.
Here you’ll find a series of posts on my old blog, that walk you through the Statement Of Cash flows, and the other financial statements. This will go a long way to helping you understand how to analyze them. Then you’ll see why I am hoping Xero will add a choice to run the Statement of Cash Flows on the Indirect Method:
Nerd’s Cash Flow Projections Archive
Simply put, the Indirect Method Statement of Cash Flows provides better information.