# Direct vs Indirect Cash Flow Forecasting

Source: https://www.cashflowforecasttemplates.co.uk/guides/direct-vs-indirect-cash-flow-forecasting
Updated: September 25, 2026

> The direct method forecasts cash by listing expected receipts and payments line by line. The indirect method starts from forecast profit and adjusts for non-cash items and changes in working capital. Small businesses and short-term forecasts almost always use the direct method; the indirect method suits longer-range forecasts built from profit and loss and balance sheet plans.

There are two ways to forecast cash flow. The **direct method** lists the cash you expect to receive and pay. The **indirect method** starts from profit and works back to cash. They arrive at the same place from different directions, and each suits different jobs. This guide explains both, with a worked example, so you know which to use.

## The direct method

List every expected receipt and payment for each period:

| | January |
|---|---|
| Opening balance | 20,000 |
| Customer receipts | 48,000 |
| Payroll | −24,000 |
| Suppliers | −14,000 |
| Rent | −4,000 |
| Loan repayment | −1,500 |
| Equipment purchase | −6,000 |
| **Closing balance** | **18,500** |

**Strengths:** easy to understand, easy to compare with the bank statement, precise about timing, and ideal for weekly and monthly management.

**Weaknesses:** needs detailed inputs, and harder to build for several years ahead.

## The indirect method

Start from forecast **profit**, then adjust to cash:

1. **Add back non-cash costs**, mainly depreciation.
2. **Adjust for working capital changes**: an increase in money owed by customers reduces cash; an increase in money you owe suppliers increases it; more stock reduces it.
3. **Add investing cash flows**: equipment purchases and sales.
4. **Add financing cash flows**: loans received and repaid, investment, dividends or drawings.

### The same January, indirect method

| | January |
|---|---|
| Forecast profit | 6,000 |
| Add back depreciation | 1,000 |
| Increase in money owed by customers | −2,000 |
| Increase in money owed to suppliers | +1,000 |
| Equipment purchase | −6,000 |
| Loan repayment (principal) | −1,500 |
| **Change in cash** | **−1,500** |

Opening balance $20,000 plus −$1,500 gives the same $18,500. The indirect method explains **why** cash differs from profit; the direct method shows **when** each amount moves.

Here, profit of $6,000 comes from sales of $50,000 less payroll, supplier costs of $15,000, rent and $1,000 of depreciation. Customers paid $2,000 less than was sold, the business paid suppliers $1,000 less than it used, the equipment was paid in cash, and loan principal was repaid.

## Where the two methods look different

- **Sales vs receipts.** The direct method records $48,000 received; the indirect method starts with $50,000 of sales and subtracts the $2,000 increase in money owed.
- **Supplier costs vs payments.** Direct shows $14,000 paid; indirect starts with $15,000 of cost and adds back the $1,000 still owed.
- **Depreciation.** It never appears in the direct method, because no cash moves. In the indirect method it’s added back to profit.
- **Equipment.** Both show the $6,000 payment, but in the indirect method it sits in a separate investing section.
- **Loan repayments.** Both show the principal; only the indirect method separates it from interest, which is already in profit.

Seeing the same month both ways is the quickest way to understand why a profitable month can leave less cash in the bank.

## When to use each

| Use | Better method |
|---|---|
| Managing the next 13 weeks | Direct |
| Monthly forecast for the next year | Direct (usually) |
| Business plans with profit and balance sheet forecasts | Indirect, or both |
| Multi-year projections for investors | Indirect, often with direct for year one |
| Explaining why profit and cash differ | Indirect |
| Comparing forecast with the bank statement | Direct |

Most small businesses need only the direct method, and many run successfully for years without ever building an indirect forecast. The indirect method becomes useful when you already forecast profit and loss and the balance sheet, typically in larger businesses or detailed investor models.

## Combining them

Many finance teams use both: a **direct** 13-week forecast for liquidity, and an **indirect** long-range forecast built from the business plan. The two should agree where they overlap. If they don’t, the gap usually points to a working capital assumption: customers paying more slowly than the plan assumes, or stock building up.

## Why the direct method suits small businesses

- **It matches how owners think**: “What’s coming in and going out?”
- **It’s easy to update**: replace forecast lines with actual figures from the bank.
- **Timing is explicit**: you can see the week payroll and a tax payment coincide.
- **No accounting knowledge needed**: you don’t need to understand accruals or depreciation.

## Understanding the indirect method is still useful

Even if you forecast directly, knowing the indirect logic helps you:

- read your accountant’s cash flow statement
- understand why a profitable year left you with less cash
- see that growth increases receivables and stock, which absorbs cash
- talk to investors who think in profit and working capital terms

See [cash flow vs profit](/guides/cash-flow-vs-profit-why-profitable-businesses-run-out-of-cash) and [working capital explained](/guides/working-capital-explained-for-small-business-owners) for more.

## Building a direct forecast

1. Enter your opening bank balance.
2. List expected receipts by week or month, based on how customers really pay.
3. List every payment, including quarterly and annual items.
4. Calculate the closing balance for each period.
5. Update with actual figures and roll forward.

The step-by-step guide is [how to make a cash flow forecast](/guides/how-to-make-a-cash-flow-forecast).

## Building an indirect forecast

1. Forecast the profit and loss account by month or year.
2. Forecast the main balance sheet items: receivables, stock, payables, loans and fixed assets.
3. Add non-cash costs back to profit.
4. Adjust for the changes in receivables, stock and payables.
5. Add capital spending and financing flows.
6. Check the result agrees with the change in the cash balance on the forecast balance sheet.

This is where accounting knowledge or an accountant’s help becomes valuable.

## Common mistakes

- **Mixing methods in one forecast**, which double-counts or misses items.
- **Forgetting working capital** in the indirect method, the usual reason it overstates cash.
- **Recording sales instead of receipts** in the direct method.
- **Treating loan repayments as costs** in profit; only interest belongs there.
- **Leaving out capital spending** in either method.
- **Adding back depreciation in the direct method**, where it never belonged in the first place.

## A note on terminology

You’ll sometimes see the direct method called the **receipts and disbursements method**, and the indirect method called the **adjusted net income method**. The ideas are the same. Whatever the name, the test of a good forecast is whether its closing balances match what later appears in the bank.

## Templates

All templates on this site use the direct method, because it’s the most practical for managing a small business’s cash: receipts and payments line by line, week by week and month by month.

### What is the direct method of cash flow forecasting?
Listing every expected receipt and payment by week or month, such as customer payments, payroll, rent and tax, and adding them up to get the closing balance.

### What is the indirect method?
Starting from forecast profit, adding back non-cash costs such as depreciation, and adjusting for changes in receivables, stock and payables, plus investing and financing cash flows.

### Which method is better for small businesses?
The direct method. It’s easier to understand, easier to update with actual figures and better for managing week-to-week cash.

### Do both methods give the same answer?
If the assumptions are consistent, yes: they arrive at the same change in cash from different starting points.

### Which method do accountants use?
Historical cash flow statements often use the indirect method. Management cash forecasts, especially short-term ones, usually use the direct method.