What is a Cash Flow Statement? Components, Methods, Examples, and Steps to Prepare a Cash Flow

How to keep track of your business cash flows? This problem has only one solution – “cash flow statement.” It keeps a record of all cash inflows and outflows of a company over a period.

This helps business owners, investors, or shareholders to analyze the company’s financial position. So, if you’re among them, you should read this article for deep insights.

Here, you can learn components, steps to prepare it, methods, and examples. Let’s go ahead!

Key Takeaways:

• A cash flow statement helps business owners to estimate the financial strength of a company.
• It consists of three components: operating, financing, and investing activities.
• Preparing a cash flow statement can be done through direct or indirect methods.
• A positive statement of cash flows helps owners to attract new investors.

What is a Cash Flow Statement?

A cash flow statement tracks the cash inflow and outflow of the company over a specific period. It is used to estimate how a business generates cash to fund future growth and other operations.

Unlike the profit and loss statement, it covers the flow of money in a business through operating, investing, and financing activities. This helps shareholders assess the company’s financial position and ability to deal with obligations.

For example, if an organization receives a cash payment from a client or pays interest on a loan, both transactions are recorded in the statement.

Components of a Cash Flow Statement

A cash flow statement includes three main components: operating, investing, and financing activities. These sections describe the type of transaction recorded in it.

Let’s take a look to understand these components!

1. Operating Activities

Operating activities include the cash flowing in and out of a company as it runs the business. It helps to determine whether the organization generates enough cash without external financing. 

• Cash Inflows: Cash received from selling property, goods, equipment, etc.
• Cash Outflows: Payments to suppliers, employees, and loans.

You should remember that positive operating cash flow indicates that the business can cover expenses. Meanwhile, a negative flow affects the working capital. 

2. Investing Activities

This section includes all activities related to long-term investments. It also includes the company’s investment in bonds and stocks. This affects the company’s growth and liquidity.

• Cash Inflows: Cash received from selling assets or collecting payments on loans.
• Cash Outflows: Capital expenditures, investments in securities, and business acquisitions.

But frequent asset sales can lead to financial distress in order to generate more cash. So, you should balance your investing activities.

3. Financing Activities

The financing activities track cash inflow and outflow from investors and lenders. It shows how an organization raises and repays capital through financing.

• Cash Inflow: Cash received from issued stocks or borrowing
• Cash Outflow: Loan repayments, dividend payments, and stock buybacks

But excessive debt can lead to financial risk if you don’t have revenue sources.

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Methods to Calculate a Cash Flow Statement

You can calculate a cash flow statement either by the direct or indirect method. Both methods generate the same result but require different information and structure.

Here are the difference of direct and indirect methods in great detail.

1. Direct Method

The direct method lists all cash paid or received from operating activities. It is more complex and requires more tracking. In this method, it doesn’t start from net income. 

For example,

• Cash collected from customers
• Cash paid to suppliers and workers

2. Indirect Method

The indirect method starts with the net income from the income statement. It also presents non-cash items and changes in working capital. This method is simple and commonly used by business owners.

For example,

• Add non-cash costs like depreciation
• Adjust transactions for changes in the balance sheet

How to Prepare a Cash Flow Statement?

You can prepare a cash flow statement by calculating all cash transactions and reviewing them. 

Here are the simple and detailed steps on how to prepare a cash flow. 

Step 1: Collect all financial information

First, you should have data such as net income, non-cash expenses, assets and liabilities, and bank statements.

Step 2: Choose a method to calculate

Now, you have to select between the direct and indirect methods according to your preferences and business standards.

Step 3: Calculate operating activities

If you are using the indirect method, you should start with the net income, non-cash expenses, and adjustments. But in the direct method, you can record actual cash inflow and outflow.

Step 4: Calculate investing activities

Next, you can calculate cash flow from long-term investments. It includes capital expenditure, asset sales, loan collections, new investments, and buying securities.

Step 5: Calculate financing activities

After this, you can compute transactions related to issuing stocks and borrowing funds. For example, debt repayments, paying dividends, and buying back stock.

Step 6: Add all activities

After calculating all activities, add them to determine net change in cash. But you should ensure that the ending cash balance matches the balance sheet’s cash account.

Step 7: Review and analyze

Now, you can review all your calculations to ensure that the outcome is correct. The positive cash flow highlights that the company’s financial stability is strong and it meets obligations easily.

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How to Read a Cash Flow Statement?

You can conduct business analysis through the statement of cash flows. It helps you gain valuable insights into a particular company before investing in it.

Here are some basic tips for better understanding. 

1. When operating activities are positive, it means that the organization generates more cash from its core operations. This influences investors to invest in a company.
2. Investing cash flow indicates how a company allocates funds for growth and expansion. It means that high capex, such as investment in building, shows expansion. But regular asset sales can lead to financial strain.
3. The steady dividend payments in the financing activities signal that the company has financial stability. It also shows the way an organization raises and repays capital.   

A Detailed Example of a Cash Flow Statement

You can take a look at the detailed example of how to prepare a cash flow statement.

For example, Wellgiver Pvt. Ltd has operating, financing, and investing activities. Let’s record them in the statement of cash flows.

Cash flows from operating activities
Net income	$150,000
Adjustments for non-cash items
Depreciation expense	$25,000
Changes in working capital
Increase in accounts receivable	($10,000)
Decrease in inventory	$8,000
Increase in accounts payable	$5,000
Net cash from operating activities	$178,000
Cash flows from investing activities
Purchase of equipment	($50,000)
Sale of old machinery	$12,000
Net cash from investing activities	($38,000)
Cash flows from financing activities
Proceeds from bank loan	$40,000
Cash paid for dividends	($20,000)
Net cash from financing activities	$20,000
Cash balance at end of year	$160,000

Note: This example is for informational purposes only.

Why Preparing a Cash Flow Statement is Important?

A cash flow statement is important to track cash flows in the company. Let’s take a look at these points to understand why it is important in a business.

1. It helps business owners improve planning through tracking cash inflow and outflow. They can easily target customers and make informed decisions about future growth.
2. When the company’s cash flow analysis is positive, it highlights financial stability. If your cash flow statement is negative, it means that you have to focus on removing internal obligations.
3. Businesses with positive cash flows help to protect their relationships with vendors, suppliers, and investors. It also opens doors for extending credit limits and bank loans.

Wrapping Up!

A cash flow statement plays a vital role in assessing the company’s financial position. The three components- operating, investing, and financing activities always give insights into all cash transactions. 

If you find preparing and reading the cash flows difficult, you can hire a financial expert or accountant. Their expertise can help you improve your business operations and contribute to expansion.

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Frequently Asked Questions

Sources:

• How to Prepare a Cash Flow Statement – Harvard Business School
• Understanding Cash Flow Analysis – IOWA STATE UNIVERSITY