Cash is the lifeblood of every business—especially new and small businesses.
Limited or inconsistent cash flow is one of the most significant challenges that small businesses face. That’s why understanding and managing cash flow is a prerequisite for success.
To get a grasp of the cash flows going in and out of your business, you need a cash flow statement. If you’re having a hard time with financial statements, don’t worry: this guide will help you create a statement of cash flows that’s easy to understand and use.
Table of contents
What is a cash flow statement?
A cash flow statement is a financial statement that summarizes the inflows and outflows of cash transactions during a given period of business operations.
The purpose of a cash flow statement is to record how much cash (or cash equivalents) is entering and leaving the company. Businesses use cash flow statements to get a detailed picture of their cash position, which is essential to a company’s financial health. You can prepare a cash flow statement in a spreadsheet, or find it in your small business accounting software.
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Many small businesses fall into the trap of focusing too much on profit and loss, ignoring company cash flow in the process. Having a clear overview of cash flows will allow you to understand where money is coming from and how it is spent. Ultimately, this will help you make more informed business decisions.
The key elements of a cash flow statement
The cash flow statement format typically includes three main components:
- Operating activities
- Investing activities
- Financing activities
Cash flow from operating activities
The operating activities in the cash flow statement include core business activities. In other words, this section measures the cash flow from a company’s provision of products or services. Examples of operating cash flows include sales of goods and services, salary payments, rent payments, and income tax payments.
Cash flow from investing activities
Investing activities include cash flows from the acquisition and disposal of long-term assets and other investments not included in cash equivalents. These represent long-term investments in the company’s growth. For instance, purchasing or selling physical property, such as real estate or vehicles, and non-physical property, like patents.
Cash flow from financing activities
Cash flows related to financing activities typically represent cash from investors or banks, issuing and buying back shares, and dividend payments. Whether you are raising a loan, paying interest to service debt, or distributing dividends, all of these transactions fall under the financing activities section in the cash flow statement.
How to prepare a cash flow statement
1. Start with net income
A cash flow statement starts with net income. Based on the income statement, it’s the profit or loss after all expenses, including taxes, have been deducted.
Net income is calculated by subtracting all operational expenses, interest payments, taxes, and other expenses from total revenue.
It’s important because it’s the basis for cash flow adjustments. Although net income is a measure of profitability, it doesn’t equal cash flow.
2. Add non-cash expenses
Non-cash expenses are adjustments made to net income to reflect the actual cash position of your business.
Depreciation and amortization are the most common non-cash expenses. Depreciation is how you spread the cost of tangible assets over their useful lives, while amortization is how you spread the cost of intangibles.
It also includes losses from the sale of assets, even though they might not have resulted in a cash outflow.
3. Subtract changes in working capital
Working capital is the difference between current assets (like cash, inventory, and receivables) and liabilities (like accounts payable and short-term debt), and may fluctuate from one period to the next.
4. Add other cash items
This step involves adjusting for other cash inflows and outflows not included in net income and working capital. These include dividends paid, interest paid, and any other cash investments or payments.
5. Calculate cash flow
The final step is to calculate the total cash flow for the period. This is done by combining the net income, adjustments for non-cash expenses, changes in working capital, and other cash items.
Based on that number, you can figure out if cash increased or decreased for the period. This is a big indicator of how well a company is doing financially, and how much cash it can generate to pay bills and invest for the future.
Why is cash flow important?
Cash flow is like having enough money in your bank account to pay your bills. If you don’t have enough cash coming in, you can’t pay for things like employees, suppliers, or rent. Just like you might plan a personal budget, businesses use a cash flow statement to make plans.
If you have good cash flow, banks and investors are more likely to lend you money or invest in you. It’s like having a good credit score that makes it easier to get a loan.
Cash flows vs. other financial statements
Financial statements are reports that summarize the financial performance of your business. A cash flow statement is one of the three main types of financial statements, alongside a balance sheet and an income statement.
In a nutshell, an income statement measures revenue, expenses, and profitability. On the other hand, a company’s balance sheet shows the assets, liabilities, and shareholders’ equity. And finally, a cash flow statement records the increases and decreases in cash.
All three financial statements are different, but they are intricately linked. Net income from the income statement feeds into retained earnings on the balance sheet, and it is the starting point in the cash flow statement.
How to calculate cash flow
Now that you know the basics of a cash flow statement, it’s time to learn two methods for calculating cash flow: the direct and indirect method.
The direct method includes all the cash inflows and outflows from operating activities, and is based on the cash basis accounting model that recognizes revenues when cash is received and expenses when they are paid. The direct method for cash flow calculation is straightforward, but it requires tracking every cash transaction, so it might require more effort.
Analyzing a cash flow statement requires understanding the context so you can make informed decisions. What stage is the business in? Is it a growing startup or a mature enterprise? The most important thing to remember is that a cash flow statement doesn’t reflect the profitability of your business, but rather the cash inflows and outflows.
- Easy to understand
- Uses real-time figures
- Takes more time and effort
- Can be an issue for businesses using accrual accounting (see below)
- Businesses using this method still need to reconcile net income with cash flow from operating activities
The indirect method calculates cash flow by adjusting net income based on non-cash transactions. This method is especially suitable for businesses using accrual accounting, where revenue is recorded when it is earned rather than when it is received. When using the indirect method, begin with the net income from your income statement, then make adjustments to undo the impact of accruals made during the period.
- Easy to prepare
- Allows for reconciliation with income statement and balance sheet
- Discloses non-cash transactions
- Lack of transparency
No matter which method you choose, only the operating activities section of your cash flow statement will be affected. The two other sections, cash from investing and financing activities, will remain the same.
Tndirect method uses net income as a base and adds non-cash expenses like depreciation and amortization. The direct method takes all cash collections from operating activities and subtracts the cash disbursements from operating activities, such as payments to suppliers and wages.
How to read a cash flow statement
The goal of the cash flow statement is to show the amount of cash generated and spent over a specific period of time, and it helps businesses analyze the liquidity and long-term solvency.
When you summarize all cash transactions, you can get a positive or a negative cash flow.
- Positive cash flow means you have more money coming in than going out. This opens up opportunities for reinvesting excess of cash in business growth. However, positive cash flow doesn’t necessarily mean that your business is profitable. There are cases where the company has a negative net income, but a positive cash flow due to borrowing activities.
- Negative cash flow indicates that you’ve spent more cash than you’ve generated during a specific period of time. Negative cash flow isn’t necessarily a bad thing, especially if it results from investment in future growth. For instance, VC-funded startups often exhibit negative cash flow, or “burn rate,” as they work to gain market share, win customers, and generate higher long-term profits. However, if you have a negative cash flow in more than one accounting period, you should consider it a red flag for your business’s financial health.
Cash flow statement example (+ template)
Now it’s your turn. Here’s a free cash flow template you can customize to fit your needs.
First, fill in your starting cash balance. Then continue by adding the cash from the company’s operations and additional cash received from activities such as sales of current assets, new investment received, etc.
Next, subtract the expenditures from operations and additional cash spent, like repayment of current borrowing, long-term liabilities repayment, etc.
After calculating net cash flow, add the starting cash balance, and you’ll get the ending cash balance for the period. Here’s a sample cash flow statement to follow.
You can also use Shopify’s cash flow calculator to easily calculate your cash flow and give your business a financial health check in less than five minutes.
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Cash flow statement FAQ
What is a cash flow statement?
What are the 3 types of cash flow statement?
- Operating cash flow: reflects cash inflows and outflows from day-to-day business operations.
- Investing cash flow: reflects cash inflows and outflows from company investments.
- Financing cash flow: reflects cash inflows and outflows from financing activities, such as taking out loans, issuing bonds or stock, or repaying debt.