Sometimes, keeping a record of your company’s financial life or balance can become quite an overwhelming task. However, it should not have to be this way. Therefore, preparing a cash flow statement on a daily basis not only helps you keep track of all financial activities of your business, it also gives you a clean and organized look into your cash flow position. Along with your company’s income statement and balance sheet, a cash flow statement is, in fact, one of the three vital financial statements which are needed in business accounting.

So, if you are a business owner and want to know more about the cash flow statement and how to easily prepare such financial statement to keep track of your business’ finances, this article will guide you through.

What is a Cash Flow Statement?

A cash flow statement, also commonly referred to as ‘statement of cash flows’, can be defined as a report of cash generated and spent for a certain period. It is a financial statement which shows the flow of money, both in and out of your business during a specific period of time. The cash flow statement thus, shows how much cash a company or business receives and spends on activities like operation, investment and other financial activities. As a business owner, using this financial statement, you can ascertain whether your company is generating more money than it is using.

The cash flow statement (or statement of cash flows) is one of the three key financial statements that report the cash generated and spent during a specific period of time (e.g., a month, quarter or year). The statement of cash flows plays an important role as a bridge between the income statement and balance sheet by showing how money moved in and out of the business.

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The three sections of the statement of cash flow are:

statements of cash flow

1. Operating Activities

The principal of revenue-making operations of an organization and other activities that are not investing or financing; any cash flows from current assets and current liabilities. Operating activities are the principal revenue-generating activities of the entity. Cash Flow from Operations typically includes the cash flows associated with sales, purchases, and other expenses.

The company’s chief financial officer (CFO) selects between the direct and indirect presentation of operating cash flow:

  • Direct Presentation: Operating cash flows are presented as a list of cash flows; cash in from sales, cash-out for capital expenditures, etc. This is a simple and easy but rarely used method, as the indirect presentation is more common.
  • Indirect Presentation: Operating cash flows are mentioned as a reconciliation from profit to cash flow. The items mentioned in the cash flow statement are not all actual cash flows, but reasons why cash flow is different from profit.

Depreciation expense reduces profit but does not impact cash flow (it is a non-cash expense). Hence, it is added back. Similarly, if the starting point profit is over interest and tax in the income statement, then interest and tax cash flows will need to be deducted if they are to be treated as operating cash flows.

No specific guidance is given on which profit amount should be used in the reconciliation. Different companies use operating profit, profit before tax, profit after tax, or net income. explicitly, the exact starting point for the reconciliation will determine the exact adjustments made to get down to an operating cash flow number.

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2. Investing Activities

Any cash flows from the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Cash Flow from Investing Activities includes the acquisition and disposal of non-current assets and other investments not included in cash equivalents. Investing cash flows typically include the cash flows associated with buying or selling property, plant, and equipment (PP&E), other non-current assets, and other financial assets. Cash spent on purchasing PP&E known as capital expenditures (or CapEx for short).

3. Financing Activities

Cash flows that result in changes in the size and composition of the contributed equity capital or borrowings of the entity (i.e., bonds, stock, dividends). Cash Flow from Financing Activities are activities that result in manipulation in the size and composition of the equity capital or borrowings of the entity. Financing cash flows include cash flows associated with borrowing and repaying bank loans, and issuing and buying back shares. The payment of a dividend is also financing cash flow.

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Example of a Cash Flow Statement

The statement is best in demonstrating investors and creditors what transactions affect the cash accounts and how effectively and efficiently a company can use its cash to finance its operations and expansions. It seems quite significant because investors want to know the company is financially sound while creditors want to know the company is liquid enough to pay its bills as they come due. In simple words, does the company have good cash flow?

The term cash flow generally refers to a company’s capability to collect and maintain adequate amounts of cash to pay its upcoming bills. The company with good cash flow can collect enough cash to pay for its operations and fund its debt service without making late payments.

Periodically reviewing your cash flow statement is essential to making sure your company is set for both good times and rough periods in the future. Here is what you need to know about preparing and analyzing your cash flow statement to best inform day to day and long-term decisions about your business’ spending and general operations.

Let’s take a simple example of a business’ cash flow statement.

Once you have evaluated the necessary elements, you can begin to build your statement of cash flows. For smaller businesses, you may not have any of the investment activities discussed previously. In this case, you would not need to enter any information.

Values in parentheses are negative, representing withdrawals or debits. Enter the values you have in the appropriate section, and then sum the values for each section.

Net Increase in Cash and Cash Equivalents is the sum of the three sections. Add this to the Cash at the beginning of the Period. The result is Cash at the End of the Period and completes your statement of cash flows.

Cash Flows From Operations

Net income: $300,000

Depreciation: ($10,000)

Accounts Payable: ($20,000)

Accounts Receivable: $10,000

Net Change: ($20,000)

Net Cash From Operations = $280,000

Cash Flows From Investing Activities

Sale of Property: $35,000

Equipment Purchase: ($15,000)

Net Cash From Investment Activities = $20,000

Cash Flows From Financing Activities

Loan Payment: ($10,000)

Loan Collection: $5,000

Net Cash From Financing Activities ($5000)

Thus, from the above example, we can see that:

Net Increase in Cash and Cash Equivalents $280,000

Cash and Cash at Beginning of Period $256,000

Cash and Cash at End of Period $536,000

How to Prepare a Cash Flow Statement

The statement of cash flows can be displayed through either the direct method or the indirect method. With either method, the investing and financing sections are identical; the only difference is in the operating section. The direct method demonstrates the major classes of gross cash receipts and gross cash payments.

The indirect method, on the other hand, initiates with the net income and adjusts the profit/loss by the effects of the transactions. In the end, cash flows from the operating section will give the same result whether under the direct or indirect approach, however, the presentation will differ.

The International Accounting Standards Board (IASB) favors the direct method of reporting because it offers more useful information that the indirect method.

1. Use of Direct and Indirect Methods

There are two well-known methods of generating a statement of cash flows, the direct method, and the indirect method.

(a) Direct Method: In the direct method, all individual instances of cash that is received or paid out are tallied up and the total is the resulting cash flow.

(b) Indirect Method: In the indirect method, the accounting line items such as net income, depreciation, etc. are used to arrive at cash flow. In financial modeling, The indirect method always produces the cash flow statement. The indirect method of preparing a statement of cash flows starts with the net profit from the income statement. Which is then set for non-cash items, such as depreciation.

2. Use Accounting Software Tools

accounting software tools

In order to ease the process of preparing a cash flow statement for your business, you can use accounting software, for instance, Intuit’s Quick Books. Accounting software will execute the required calculations for you, and you can schedule weekly or monthly cash flow statements.

In your accounting software’s cash flow analysis feature, start by entering your company’s net income and cash balance at the beginning of the tracking period. This number should include all of the company’s bank account balances as well as any petty cash. For each category, mark inflows as positive and outflows as negative. Double-check that you have entered all your expenditures and incomes for the analysis period.

The software should include everything up, category by category, and then total the balance of the three categories. You will also be able to see your final cash balance. Eliminate 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.

With quick books’ offering features, you can easily compare cash flow for different time periods. This is especially useful when discussing company goals and growth targets or when planning big investments.

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What Can a Cash Flow Statement Tell You

The cash flow statement is a report that can show details on many financial aspects of your business. This will further help you in managing your finances.

  • Cash from operating activities compared to the company’s net income to determine the quality of earnings. In case, the cash from operating activities is higher than net income, earnings are of “high quality”.
  • This statement fruitful to investors because, under the notion that cash is king, it allows investors to get an overall sense of the company’s cash inflows and outflows.  And obtain a general understanding of its overall performance.
  • When a company is funding losses from operations or financing investments by raising money (debt or equity) it will quickly become clear on the statement of cash flows.

Bottom Line

The statement of cash flows provides valuable information about a company’s gross payments and receipts and allows insights into its future income needs. Figures from your cash flow analysis can also assist you measure other areas of your company’s financial health.

For instance, 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. Finally, 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 detecting 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. These top-level cash flow analytics can give you a bigger picture view of your company’s finances.

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