What Is a Cash Flow Statement and How to Make One

As a business owner, keeping track of the financial situation of your company is vital for success and decision-making.

One of the most important financial reports that detail the cash inflows and outflows of a business over a specific period is the cash flow statement.

This must-have financial document gives valuable information about the company’s liquidity, financial health, and ability to manage cash for operations, investments, and financing activities.

In the following sections, we take a deep dive into the topic exploring what a cash flow statement is, why it matters, and how to create one. 

What Is a Cash Flow Statement?

A cash flow statement, also known as a statement of cash flows or CFS, is a financial report that outlines a business’s cash inflows and cash outflows throughout a specified period. 

As one of the three core financial statements (along with the balance sheet and income statement), it demonstrates the cash generated or cash paid by a company. It enables the connection between the income statement and the balance sheet by revealing how much cash moved in and out of the business. 

In order to truly understand the cash flow statement, it’s essential to define three fundamental terms:

• Cash flow – the way cash and cash equivalents are moving in and out of the company
• Cash balance – cash available on hand (represented in the balance sheet under “cash balance”)
• Cash equivalents – consist of cash in the form of bank deposits, short-term investments, and quickly cash-convertible assets (like overdrafts and other alternatives with short-term maturities)

Put simply, cash comes into the company when customers purchase from you or when you sell other assets. It leaves the business when you spend to acquire assets, invest, and more. 

However, the cash flow statement can get complicated, especially if you’re not fully familiar with the foundations. 

What Is the Purpose of the Cash Flow Statement?

The cash flow statement is incredibly important, no matter how small or large your business is. 

This is because it demonstrates essential information that’s not presented in the income statement or balance sheet for a specific reporting period. It focuses on what happens to the company’s cash over a given period, thus providing vital data about the company’s financial health and liquidity. 

Together, the balance sheet, income statement, and cash flow statement offer a complete picture of the financial condition of the business.

In addition, the cash flow statement enables comparisons between operating cash flow and net income. This can help identify how a company is managing its operating expenses as the cash flow mirrors the actual cash flow the company generates from operations. 

The Components of a Cash Flow Statement

The cash flow statement comprises three essential components – operating activities, investment activities, and financing activities. 

Here’s everything you need to know about each one. 

Operating activities

Cash flow from operating activities is the cash related to the core operations of the business, such as revenue from sales and payments for operating expenses. These cash flows can be compared to the company’s net income with the aim of identifying how valuable earnings are for the business. 

In cases where cash from operating activities is more than net income, analysts would conclude that the company’s earnings are high quality. 

Cash flow from operating activities is significantly important for investors as it helps them get an idea of the actual performance of the business. Not to mention that operating activity cash flows also offer transparency as they immediately show whether the company’s been funding losses from operations or covering investments by raising money. 

Investing activities

Cash flow from investing activities includes buying or selling assets with free cash instead of debt. This could include transactions for real estate, equipment, patents, fixed assets, marketable securities, and more. 

Under this section, analysts search for changes in capital expenditures. 

Note that investing activities include gains and losses, giving insights into the bigger picture rather than simply focusing on cash earned or cash spent. 

Financing activities

Finally, the financing activities section of the cash flow statement shows transactions involving debt, equity financing, and dividend payments. As the name suggests, it demonstrates cash flow accumulated by the way the company is financed. 

In most cases, businesses are financed by a combination of debt and equity or shareholders’ cash. For example, cash from financing activities might consist of cash from new borrowings, cash flow related to shareholders (cash receipts after a new share issue), cash repayment of debt, or others. 

Once you’ve calculated all of the cash generated by operating activities, investing activities, and financing activities, you’ll have the “net cash flow” of your company. 

Methods for Preparing a Cash Flow Statement

There are two core methods used for preparing a cash flow statement – the indirect and direct methods. Each of them comes with its benefits and drawbacks. 

Some companies prefer to use one over the other, yet both are accepted by Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).

Direct Method

The direct method of preparing a cash flow statement is considered to be more instinctive as it begins with operating cash flows. It demonstrates the main classes of gross cash receipts along with gross cash payments. 

In a nutshell, the direct method tracks actual cash receipts and payments during a specific period.

It offers a much clearer view of cash sources and uses, but at the same time it requires detailed records of all cash transactions. 

Indirect Method

The indirect method of preparing a cash flow statement starts with a net income figure derived from your income statement and then aligns with non-cash items. For example, this could include accruing expenses like depreciation or amortisation. After that, it makes adjustments based on cash-based transactions. 

If an asset account grows, under the indirect method the increase is subtracted from net income. On the other hand, a rise in liability is reflected as an addition to net income. 

By using this method, companies can easily adapt alterations to working capital like accounts receivable, accounts payable, and inventory. The indirect method is also easier to work with if you have existing data from financial statements. 

However, it’s considered less detailed than the direct method when it comes to showing the origins of cash flow. 

Steps to Create a Cash Flow Statement

So, how can you create a cash flow statement for your company?

Below, we share an easy-to-use, step-by-step process to calculate cash flows.

Step 1: Gather Financial Data

At the very start, it’s important to ensure you collect data from the income statement, the balance sheet, and any records you have of cash transactions. 

Make sure that you have access to data on accounts receivable, payable, inventory, and non-cash expenses.

Identify the starting balance of cash and cash equivalents at the start of the reporting period. You’ll need this figure if you’ve decided to work with the indirect method of calculating cash flow from operating activities. 

Step 2: Calculate Operating Cash Flow

Next, it’s time to determine your cash flow from operating activities. This will show what portion of your company cash derives from operations.

To calculate operating cash flow, you can either use the direct or indirect methods outlined above. 

When working with the direct method, simply take all cash from operations and subtract all cash payments from operations. For example, add cash received from clients and take away cash used to cover operating expenses like wages, income taxes paid, interest paid, utilities, and others. 

When working with the indirect method, start with net income and adjust for non-cash transactions, like depreciation and amortization. Don’t forget to take into account working capital like accounts receivable and inventory. 

Both the indirect and direct methods should give you the same number.

In short, some of the transactions you’ll need include:

• Cash receipts from customers; 
• Cash paid to suppliers;
• Cash paid to employees;
• Interest paid;
• Income taxes paid; 
• Depreciations;
• Amortization;
• Dividends received.

Make sure you carefully add and subtract these to get an accurate net cash flow from operating activities. 

Step 3: Calculate Investing Cash Flow

The third step is calculating cash flow from investing activities. This is the cash spent or earned in relation to the acquisition or sale of long-term assets. 

These include:

• Purchase or sale of an asset;
• Loans made to suppliers;
• Merger and acquisition payments.

Simply record cash outflows for any purchases you’ve made and inflows from selling assets or receiving investment returns. 

Step 4: Calculate Financing Cash Flow

Finally, calculate the cash flow from financing activities. 

Add the cash inflows from issuing stock or borrowing funds and subtract spending for loan repayments or dividend payments. 

The core elements to factor in this section are:

• Dividends paid; 
• Net borrowings; 
• Repayment of debt principal;
• Sale or repurchase of company stock. 

Note that if you’re adhering to GAAP, financing cash flow should include dividends paid, which can also be recorded in the operating cash flow section for companies adhering to IFRS standards. 

Under GAAP, interest paid is recorded in operating cash flow, but on some occasions, it’s recorded in the financing section under IFRS.

Step 5: Compile the Cash Flow Statement

Finally, combine net cash flows from operating, investing, and financing activities to get the final figure. 

Add the beginning cash balance to determine the ending cash balance. Cash flow is different for every company. In some cases, the business has a positive cash flow, while in others, it’s negative.

Positive cash flow means that more money is entering the business during a given period than leaving it. This is the best case scenario for any company as it shows financial stability and effective management. 

On the other hand, negative cash flow means that more cash is leaving the company than coming in. Although this may be alarming for most, it’s not always something to worry about. This could be a result of current investments being made for the expansion of the business or other important activities that are bound to prove profitable in the future. 

At the same time, negative cash flow can also mean low liquidity and cash flow issues. 

Benefits of a Cash Flow Statement

Overall, creating a cash flow statement for your business can offer multiple benefits:

• Enables financial health assessment – Reveals liquidity and the company’s ability to meet short-term obligations.
• Improves business planning and decision-making – Helps allocate resources effectively and plan for investments or expansions.
• Helps identify cash flow issues – Pinpoints cash flow shortages or surpluses to inform corrective actions.

Considering these advantages, it’s natural that this financial document is a core asset for any organization that helps make data-driven decisions and financial improvements.

Tips for Effective Cash Flow Management

If you’ve found that your cash flow is negative and you’d like to see improvements, the good news is that there are plenty of options to explore.

One proven strategy for effective cash flow management is to make sure you’re regularly monitoring your cash inflows and outflows. Create monthly or quarterly cash flow statements to track trends, which will allow you to quickly spot opportunities for enhancement and more liquidity.

In addition, use historical data to predict cash coming in and leaving the company in the future. Despite external factors influencing your predictions, a financial forecast can help you stay in as much control as possible when it comes to spending.

This brings us to the next point – controlling expenses. Identify any unnecessary spending and cut down costs if possible to make sure you have more available cash for investments or covering urgent expenses.

Most importantly, optimize receivables by implementing strategies to ensure that your customers pay on time. You can do this by relying on accounting software and tools designed to help with payment collection. 

For instance, this could mean using mobile invoices to conveniently collect payments from clients and partners.

In a Nutshell

In conclusion, the cash flow statement is an essential financial tool for understanding how cash moves through a business.

Without a cash flow statement, it would be impossible to understand the current state of the business, its level of liquidity, financial health, and future growth potential. 

We hope that this article will help you acquire the foundational know-how on cash flow statements and will enable you to prepare your first report.

Frequently Asked Questions

What is shown in the cash flow statement?

The cash flow statement focuses on three core sections – investing activities, operating activities, and financing activities. As a result of calculating these three components, it reveals how cash moves in and out of a business.

What’s the difference between a cash flow statement and a balance sheet?

While the cash flow statement tracks the movement of cash in and out of a business during a specific period, the balance sheet provides a snapshot of a business’s financial position at a specific point in time, showing assets, liabilities, and equity.

What’s the difference between a cash flow statement and an income statement?

In short, the cash flow statement highlights cash movement, while the income statement emphasizes financial performance. The income statement depicts a company’s profitability by detailing revenues, expenses, and net income over a specific period, including non-cash items like depreciation.