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A cash flow statement, also known as the statement of cash flows, is a financial statement that shows the flow of cash into and out of your business during a specific period of time. This report shows how much cash a company receives and spends on operating, investing, and financing activities. The statement of cash flows is one of the core financial statements, along with the income statement and balance sheet, used to evaluate a business’s financial situation.
Tracking your company’s cash balance can feel like an overwhelming task—but it doesn’t have to be. Preparing a cash flow statement on a regular basis gives you a clear, organized look into your cash flow position, a crucial piece in your business finances. In fact, along with your income statement and balance sheet, a cash flow statement, also known as a statement of cash flows, is one of the three major financial statements in business accounting.
Therefore, periodically reviewing your cash flow statement is essential to making sure your company is prepared for the future. This being said, however, you might be wondering: What exactly is a cash flow statement and how does it work?
We’re here to help. In this guide, we’ll break down a cash flow statement definition, discuss what this financial report looks like, and explain how to prepare one for your business.
Let’s start with the basics.
In short, a cash flow statement (also called a statement of cash flows) is a financial report that shows how cash has moved in and out of your business during a specific period of time. As such, the cash flow statement is used to evaluate how much cash your business brings in, and therefore, how your business manages both expenses and debts. In this way, the statement of cash flows reconciles the income statement and the balance sheet—serving along with those two reports as one of the three core financial statements for any business.
Certainly, the cash flow statement can be one of the most important reports to indicate how financially healthy a business is. In fact, it’s very likely that both investors or lenders will want to see a statement of cash flows to determine whether or not to work with your business.
So, before we get into what a cash flow statement looks like, let’s follow up on our last point—and explain further how you, as well as third parties, will use your statement of cash flows.
First, performing a cash flow analysis allows you to track changes in your business’s cash balance during a specific period by calculating cash inflow versus cash expenditures.
This process will help you to identify patterns, not only around how much money is coming in and going out of your business, but also for what and when—enabling you to plan ahead and avoid being short of cash when bills and payroll are due.
Additionally, as we mentioned above, your cash flow statement will also give you a snapshot of your business’s financial health: whether or not your everyday operations (without outside help from investors or loans) are generating enough money for the business to sustain itself. This is your company’s liquidity—an important factor for monitoring for the longevity of your business.
Therefore, it’s smart to run a cash flow statement on at least a monthly basis. However, if you’ve had recent cash flow problems, it may be worthwhile to track your cash flow weekly or even daily for awhile—the more frequently you update your cash flow statement over time, the more apparent patterns of cash flow in your business will become, and the better you’ll be able to predict (and prepare for) leaner times.
This being said, as we mentioned, the cash flow statement is different from an income statement as well as from a balance sheet, but together, these three reports make up the core financial documents that not only show the status of your business finances, but are also the ones that an investor or lender will likely want to see to determine whether or not to work with your business.
A lender, for one, will use the cash flow statement and other reports to evaluate your business’s creditworthiness—in other words, how capable you are to pay back any debt you take on. With investors, these financial statements will help them judge whether your business finances are healthy and whether it seems like you’re on the path to success—and therefore, whether or not they should invest.
With this overview in mind, let’s break down what a cash flow statement looks like and what you should expect to include when creating one for your business.
As we’ve mentioned, the statement of cash flows is basically a snapshot of your business’s financial health. This being said, the cash flow statement can be presented in two formats:
Ultimately, whichever presentation method you use, the end result should be the same. This being said, the method you choose is up to you—most businesses use the indirect method, the International Accounting Standards Board (IASB), however, recommends the direct method.
For the purpose of this guide, we’ll focus on the indirect method because it’s so much more commonly used.
With this in mind, no matter which format you use, your cash flow statement should be divided into three parts: cash associated with operating, investing, and financing activities. A healthy business drives their cash flows from operations and reinvests capital—this means you want to see net positive cash inflows from operations and cash outflows for investing activities.
Here’s what each of these parts should contain:
All of this being said, it’s important to remember that the cash flow statement is only concerned with cash and cash equivalents (e.g. checks, bank accounts, and U.S. treasury accounts). For example, if your accounts receivables go up, that means sales are up, but you haven’t received cash at the time of sale. As a result, accounts receivables will be deducted from your net income and actually get treated as a cash outflow on your cash flow statement. Conversely, an increase in accounts payable will show up as an inflow on your cash flow statement because you haven’t paid for those goods or services yet.
As you can see in the image below, the final line on your cash flow statement shows your net cash balance, in other words, the amount of cash your company has on hand during the reporting period. If your business is generating more cash than it’s using, this should be a positive number.
Example of a cash flow statement template.
Now that we know what parts make up a cash flow statement and what this financial statement should look like, let’s take a look at an example.
Here is an indirect cash flow statement example, with $150,000 net income as a starting point:
As you can see in this cash flow statement example, the items are broken into the three categories—operating, investing, and financing activities—and concludes with a net cash balance. This sample company had a positive net cash balance at the end of the first quarter in 2019. Most of the positive cash inflows came from operating activities ($190,000), which is a good sign. The company also made some good long-term investments in plant, property, and equipment. The business also doesn’t seem to be borrowing too much money.
This being said, it’s important to note that although depreciation appears on the cash flow statement, depreciation is not a source of cash for a business. However, it is listed on the indirect cash flow statement to adjust net income, which is reduced by depreciation expense on the income statement.
With this in mind, if you’re looking to get even more out of your cash flow statement, you can perform a common size analysis on your financial statements. With common size analysis, you’ll be able to see what percentage of your net revenue is made up by each line item in your cash flow statement. This type of analysis will allow you to make informed decisions about where to increase spending and where to cut back.
Based on this breakdown, you should have a fairly comprehensive idea of the pieces that make up a cash flow statement. For more guidance, however, you can check out this video from Fundera contributor Seth David:
So, now that you know what a cash flow statement is and how it works, you’re likely wondering how to actually prepare one. You can, of course, use a template, like the one shown in the image above, and pull the numbers required, manually filling in the spreadsheet and completing your cash flow statement.
Perhaps the best way, however, to prepare a cash flow statement, is to use automated accounting software. An accounting software, like QuickBooks Online, Xero, or Wave, will allow you to maintain your books, including all of the pieces that are required for a statement of cash flows. Then, you’ll actually be able to generate this financial statement automatically through your software platform. The accounting software will make the required calculations for you, and you can schedule weekly or monthly cash flow statements.
All you have to do is locate your accounting software’s cash flow analysis feature and start by entering your company’s net income and cash balance at the beginning of the tracking period. This number should include all of your company’s bank account balances as well as any petty cash.
Then, for each category, you’ll mark inflows as positive and outflows as negative. You’ll want to double check that you’ve entered all your expenditures and incomes for the analysis period. At this point, the software should add everything up, category by category, and then total the balance of the three categories. You’ll then be able to see your final cash balance. You can subtract your starting balance from your ending balance for the period to determine whether your cash flow over the statement period in question was positive or negative.
Ultimately, using accounting software is going to be the easiest and most efficient way to prepare a cash flow statement—as well as manage the whole of your business finances, for that matter. By taking advantage of the automation of one of these platforms, you’ll be saving yourself time, hassle, and certainly, decrease your likelihood of errors. Plus, with accounting software like QuickBooks, you can easily compare cash flow for different time periods. This feature will be especially useful when discussing company goals and growth targets or when planning big investments.
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Once you’ve learned how to prepare your cash flow statement, you’ll want to know how to make the most out of it.
How can you use this report to better inform your spending and sales decisions?
To start, you can simply look at whether your cash flow during the analysis period was positive or negative. If you see a pattern of negative cash flow over several months, it’s likely time to implement cost-cutting or revenue building measures to work toward positive cash flow. You might consider raising prices, cutting down excess inventory, changing marketing tactics, or adjusting your staffing schedule to realign your cash flow in a better direction.
This being said, figures from your cash flow analysis can also help you measure other areas of your company’s financial health. For example, you can look at the ratio between your operating activities cash flow (day-to-day cash expenditures and income) and your net sales to see how much cash from sales is going into your company’s pocket rather than to overhead. Ultimately, you want your cash flow to increase as sales increase, meaning that your cash profit from sales is holding steady.
Once you’ve mastered the basics of tracking and analyzing your company’s cash flow, you might want to investigate some more complex figures, such as your company’s free cash flow—an important number for venture capitalists and others who may consider investing in your business. These higher-level cash flow analytics can give you a bigger-picture view of your company’s finances.
At the end of the day, it’s important to understand how a cash flow statement works and how to prepare one for your business. As one of the three key financial statements, once again with your income statement and balance sheet, your cash flow statement will help you evaluate your business’s financial health and hopefully, you’ll be able to use this report to grow your business, gain investors, and secure any additional financing you need.
This being said, in order to optimize your financial process and make it simpler to maintain your books and generate your statement of cash flows, we’d recommend investing in accounting software such as QuickBooks, Wave, or Xero. Moreover, if you ever have questions or problems with regard to your finances and are looking for assistance, it always helps to find a business accountant you can rely on and trust and use this professional’s services for the lifecycle of your business.