Everything You Need to Know About Cash Flow Statements

What is a cash flow statement?

A cash flow statement, also called a statement of cash flows, is a financial document showing how money flows in and out of your business. Common financial activities, such as securing loans or applying for investment capital, may require this and other types of financial statements.

Cash flow statements are used to evaluate the financial health of a business and provide a picture of how you spend and invest the money. 

Editor’s note: Looking for the right accounting software for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

How to use a cash flow statement

Inadequate cash flow can keep your business from paying its bills in the short term and expanding in the long run. Cash flow is not only the most critical facet of your business but it also matters to outside investors and lenders. Many common financing activities require you to provide financial statements, including cash flow.

While your company’s financial health shouldn’t be judged based on one aspect, your cash flow statement is a valuable document that can help you operate efficiently, pay bills at the right time, make more accurate future projections and grow. Specifically, the cash flow statement will:

Predict when revenue will come in

A proper cash flow statement accurately predicts when the company will receive revenue. This will involve sales forecasting for companies that sell products or services for immediate payment, such as e-commerce or retail stores. For companies that sell on credit that they extend themselves or for service companies, such as consulting firms, it involves not just a prediction of when the sale will be made but also when payment will be received. These forecasts should be updated continually as new data becomes available.

Ramp up sales and marketing

If the cash flow statement shows a dip in forecasted revenue, the company can decide to take action to bring in more revenue. For example, it could announce additional bonuses to salespeople who hit short-term sales targets or it could run a promotion to unload older inventory items. 

The cash flow statement will inform management about what marketing or sales-boosting tactics are best at the time. In a very low cash outlook, the company might focus on performance-based methods, such as affiliate marketing, sales commission bumps or bonuses that are paid later. If the cash situation is not as bad now but is forecasted to become worse, the company might instead opt to spend some money on digital advertising to generate a pipeline of leads that will close when needed.

Focus on collections

When you have a lot of accounts receivable (AR) that are causing a cash flow problem, you should focus on accelerating your collection activity. There are a variety of ways to do this. For example, you could give clients a discount for paying upfront, tighten their credit terms, send collection letters to late accounts or refer very delinquent accounts to top collection agencies or attorneys.

Decide when to pay larger bills

Based on when the company has cash in hand, it can then decide when to pay larger bills to vendors with credit lines or payment terms. Payments can be made immediately when the company is flush with cash to ensure that the product or raw material continues to flow. Conversely, payment can be delayed or the company could even renegotiate its terms, during a slow period.

Show you if you need a loan

If you have a business on the books and are profitable but do not yet have money flowing in, your cash flow statement will show you if you need to take in some short-term financing, such as a bridge loan. In this situation, your business is a good risk for a lender, and the funding will allow you to pay your bills until you start receiving revenue from your sales. It also lets you know how much to borrow so you aren’t paying interest on money you don’t need.

Indicate if your startup needs an investor

Startup businesses should create cash flow statements as part of their pro forma financial documents. This shows all of the business’s startup costs, the founders’ investment and any shortfall. The shortfall needs to be financed somehow, either by an angel investor or a business loan.

Let lenders or investors know how liquid the company is

When looking for a loan or investment, a cash flow statement is needed. The more cash you have available, the more liquid you are and the more attractive (lower risk) you look to potential lenders or investors. 

The parts of a cash flow statement

To understand the cash and cash equivalents flowing through your business, you’ll need to put together a cash flow statement, which is usually split into three sections. These are the most common terms, but there may be some variations by industry and region. These are the three sections that are typically included:

Cash flow from operating

Often referred to as “cash from operating activities,” this usually is first. It covers the incoming cash from sales or contracts and the outgoing payments for operational expenses, such as taxes, staff or manufacturing costs. 

Cash flow from investing

The investing section records capital expenditures, acquisitions and divestments. Expenditures and acquisitions are both cash outflows while divestments are cash inflows. It’s not unusual for this section to primarily consist of cash outflow as many thriving businesses spend more money investing than they do cashing out investments.

Cash flow from financing

In this section, detail how your company is funded and distributes its funds. Data in this portion may include transactions concerning company debt and equity. If your company pays dividends to shareholders, you would capture that here.

How to calculate cash flow

To calculate your business’s cash flow, you add or subtract differences in your net income based on information from your balance sheet and income statement. The adjustments are made to revenue, expenses and credit transactions because net income includes noncash items. These are methods used to calculate cash flow.

Direct cash flow method 

This method is preferred by the Financial Accounting Standards Board because it shows the actual flow of cash in and out of a business. Using the beginning and ending balances of your accounts, calculate all cash payments and receipts.

Group cash transactions by type: 

• Operating cash flow: Cash received from customers, cash paid to suppliers and for other operating expenses, such as salaries, rent and raw materials:
  • Cash received from customers = Sales + decrease or – increase in AR
  • Cash paid to suppliers = Cost of goods sold + increase or – decrease in inventory + decrease or – increase in accounts payable (AP)
  • Cash paid for operations = Operating expenses + increase or – decrease in prepaid expenses + decrease or – increase in accrued liabilities
• Financing cash flow: Interest payments received and interest paid
  • Cash interest = Interest expense – increase or + decrease in interest payable + amortization of bond premium or – discount
• Taxes cash flow: Income tax refund received and income tax paid (sales tax received and paid should be equivalent)
  • Cash for income taxes = Income taxes + decrease or – increase in income tax payable – income tax refund
• Other cash flow: Any other cash received, such as investment capital

Indirect cash flow method

This method to calculate cash flow starts with net income from your income statement. It only accounts for revenue that has been earned. Next, you adjust any earnings before interest and taxes for transactions impacting your net income. Then, you add transactions that have no impact on your business’s cash flow, such as depreciation.

• Cash flow from operations = Net income + depreciation and amortization + AR + inventory + AP
• Cash flow from investing – Incoming investment cash – outgoing investment cash 
• Cash flow from financing = Incoming financing cash – outgoing financing cash 
• Net change in cash balance = Operating cash flow + investing cash flow + financing cash flow
• Cash balance at the end of the period = Net change in cash balance + cash balance at the start of the period

AR

Cash flow statements should always include changes in AR during each accounting period. A decrease in AR indicates an increase in cash from customers who have paid off their accounts. This results in increased net earnings. However, an increase in AR should be deducted from net earnings because it is not an increase in cash.

Inventory value

An increase in inventory should be reflected as a deduction from net earnings because it indicates money your company has spent (if it was paid in cash). Inventory purchased using credit would be reflected on your balance sheet as an increase in AP, with the increased amount added to net earnings each year.

Risks of relying only on a cash flow statement

While cash flow statements are an important and useful tool, they should not be the only financial statement you use to make decisions and assess the health of your business.

When your cash flow looks bad

If you are looking at your cash flow statement and seeing that the cash isn’t flowing, don’t panic. It is important to look into the reasons for this. It could be that you just paid to buy some equipment that will lower your operating costs going forward or it might be that you haven’t received some investment or sales revenue yet. 

When your cash flow looks good

Meanwhile, just because your cash flow statement looks good, it doesn’t mean that everything is fine. You might have gotten some revenue in a big chunk but there are even bigger expenditures on the horizon or perhaps your margins are too low. 

To really know what is going on, you need to look at all of your financial statements such as your balance sheet and income statement. In addition, you need to have a solid understanding of your revenue and expenditure forecasts. For example, you may see a large marketing expenditure on the books, but you should talk to your marketing manager to see how much revenue that expenditure is projected to generate.

Differences between cash flow statement, income statement and balance sheet

Cash flow statement

A cash flow statement, as its name implies, shows how and when cash flows into and out of your business. How much cash you have on hand determines when you can invest or pay bills and whether you need to focus on bringing in more revenue.

Income statement 

The purpose of an income statement is to show how much profit the company has made (or lost) in a particular period of time. It includes AR on the income side even if that money has not yet been collected and AP on the expense side even if it hasn’t yet been paid. In addition, the income statement includes depreciation expense, which is not an actual cash expense but rather a portion of the original cost of an investment. These include equipment that is deducted as the asset becomes older and less useful.

Balance statement

Balance statements show the company’s financial position in terms of how much value it has. Value is determined by the value of its assets minus how much it owes (its liabilities). The result, or value of the company, is the shareholders’ equity. Cash on hand and AR are counted among the assets and AP are one of the liabilities. Other assets include real estate, vehicles and equipment that are already paid for and thus do not have an associated ongoing cash payment.

Cash flow statement example (direct method)

See below for an example of a cash flow statement done with the direct method.

Cash flow statements FAQs

What is the difference between a cash flow statement and a cash flow forecast? 

A cash flow statement shows the incoming and outgoing cash expenditures that have already happened during a specific period. A cash flow forecast is a month-to-month projection showing anticipated cash flow over a period of a year. Typically, it is used for startups as one of the pro forma financial statements included in their business plan.

Who would typically prepare a cash flow statement?

The cash flow statement would usually be prepared by either the chief financial officer, comptroller, accountant or bookkeeper of a business. In a startup, it might be prepared by an outside accountant or by the founder.

How does profit margin impact cash flow?

A company can be profitable and still have problematic cash flow if the sales cycle is long and customers are slow to pay. In addition, a profitable company that is a startup or is in the midst of growth investment might show low or negative cash flow because of its initial or short-term expenditures. However, the more profitable a company is, the more cash flow positive it should be in the long term. 

What is the difference between net income and cash flow? 

Net income is the bottom line on your income statement, showing you how much money the company made after expenses during the period. Cash flow only shows the changes in cash balances from one period to the next. 

Can cash flow be negative? 

Yes, it will be negative when you have spent more cash than you have brought in during that period. Continued negative cash flow means that your company is failing but, if it is just for a short time, it either signals that you have had large one-time purchases or that your revenue needs to increase, expenses decrease, collections activity improve or you need a loan or investment. 

What is the easiest way to create a cash flow statement? 

The best accounting software applications have a preconfigured report for cash flow statements. You can also find an online template if you’re not yet using a software program. If you utilize a template, make sure to choose one that matches your needs and reporting schedule.

Accurate tracking is an important task in managing your business’s finances. Without accurate tracking, even the best template, income statement or balance sheet will be useless. Accounting software that helps manage your financial tracking usually pays for itself in the short term.

How can I learn more about cash flow and other financial statements? 

The United States Securities and Exchange Commission publishes many helpful guides, such as the Beginner’s Guide to Financial Statement. If you’ve never read a balance sheet or put together a profit and loss statement, it will give you the background you need.

Mona Bushnell contributed to this article.