Accounting

Cash Flow Statements: The Complete Guide

Aug 10, 2022 | By Michael Whitmire

cash flow statement

What Is a Cash Flow Statement?

Many business owners think of business success in terms of profits. While profits are certainly important, it's entirely possible for a company to report profits but go out of business. How does this happen? Often, it's because they ignore cash flows.

A cash flow statement can be a valuable tool for tracking an organization's cash flow, preparing cash flow forecasts, and making short-term business plans.

Here's a look at what a cash flow statement is and how to prepare one.

What Is the Formula for Cash Flow Statement?

A cash flow statement is one of the three key financial statements, along with the balance sheet and income statement. It shows the sources and uses of cash from three main business activities: operating activities, investing activities, and financing activities.

The formula for a cash flow statement is:

Beginning cash balance + Cash flows from operating activities + Cash flows from investing activities + Cash flows from financing activities = Ending cash balance

Structure of the Cash Flow Statement

Let's look at each of those three areas in more detail to understand the formula for the cash flow statement.

  • Operating activities either generate revenue or incur expenses to produce the company's products or services.
  • Investing activities are the gains and losses from investments in assets, including real estate, property and equipment, vehicles, and marketable securities.
  • Financing activities record the cash flows between the company and its owners and creditors. Examples include taking out loans, loan repayment, owner's equity investments, and paying dividends.

Why Use a Cash Flow Statement Template?

A cash flow statement template is a prestructured form that helps you create a statement of cash flows. It saves time by allowing you to simply plug your numbers into the right spots.

A cash flow statement template also ensures you use a widely accepted and understood format. Lenders and investors often want to review your statement of cash flows before making a loan or investing money in your business, so using templates ensures your financial statements are accurate, professional, and easy to read.

SCORE offers a helpful 12-month cash flow statement template for Excel that you can use to project your free cash flow if you're just starting a business. Most cloud accounting software also includes a cash flow statement as one of its standard reports.

How to Prepare a Cash Flow Statement

Here are four steps to help you create your own cash flow statement.

1. Determine your starting cash balance

The first step in creating your cash flow statement is to determine your beginning cash balance. This should include cash in your bank accounts, cash equivalents, petty cash, and cash on hand.

2. Calculate cash flow from operating activities

There are two ways to calculate operating cash flows: the direct method or the indirect method.

Both U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) allow companies to use either the direct or indirect method for preparing a statement of cash flows.

The direct method itemizes the cash received from customers and cash payments for supplies, staff, debt and income tax payments, etc. It ignores non-cash transactions, such as depreciation or accrual basis transactions.

However, most companies and accountants prefer the indirect method because the data needed to prepare it has already been collected in the company's financial statements.

The indirect method starts with the company's net income from the income statement, then makes adjustments to undo the impact of accrual accounting and other transactions that impact the income statement but don't impact cash or belong in another section of the cash flow statement.

Common adjustments in the operating activities section include:

  • Adding back depreciation on fixed assets
  • Adding/deducting a decrease/increase in accounts receivable
  • Deducting/adding a decrease/increase in accounts payable
  • Deducting/adding an increase/decrease in inventory
  • Adding/deducting an increase/decrease in accrued expenses

3. Calculate cash flow from investing activities

Calculating the investing activities section involves detailing the cash flows from buying and selling long-term assets, including land, buildings, vehicles, and equipment.

Remember that this section only includes investing activities that impact cash—purchases financed with debt belong in the financing activities section.

Common adjustments in this section include:

  • Capital expenditures paid for with cash
  • Cash receipts from the sale of equipment
  • Interest received

4. Calculate cash flow from financing activities

This section reports cash inflows and outflows from debt and equity financing—raising cash and paying back investors and creditors.

Common adjustments in this section include:

  • Funds from new short- or long-term debt
  • Principal payments on notes payable
  • Proceeds from issuing stock
  • Dividends paid to shareholders
  • Repurchase of treasury stock

5. Calculate your ending cash balance

Finally, add up the cash provided or used by operating, investing, and financing activities. The result is the net increase or decrease in cash for the specific period covered by your cash flow statement.

If the number is positive, you have positive cash flow. If the number is negative, you spent more cash than you brought in.

When you add that net increase or decrease in cash to your beginning cash balance, the result should equal your cash balance for the accounting period shown on the company's balance sheet.

If your ending cash balance on your statement of cash flows doesn't match the cash balance on your balance sheet, you've made a mistake somewhere and will need to investigate the difference.

Limitations of the Cash Flow Statement

A cash flow statement is valuable for showing the company's cash position and net cash flow. Still, you can't interpret company performance solely by looking at the statement of cash flows.

There are several limitations to this financial statement, including:

  • It doesn't lend itself to comparisons with industry benchmarks. Lenders, investors, and business leaders often compare their balance sheet and income statement numbers to industry averages to measure the company's efficiency and financial health. The cash flow statement doesn't measure a business's economic efficiency, so comparisons to other companies within the industry aren't very useful.
  • It doesn't provide information on liquidity or solvency. Liquidity and solvency are essential to a company's financial health. Liquidity refers to the organization's ability to pay its current liabilities using its working capital. Solvency refers to its ability to meet its long-term financial commitments. A cash flow statement only presents the company's cash flow over a period of time and cash position as of a particular date, so it doesn't provide information for a complete financial analysis of the company's solvency or liquidity position.

To get an overall picture of a company's profitability, efficiency, liquidity, and solvency, you need to analyze its balance sheet and profit and loss statement in addition to the statement of cash flows.

How to Interpret a Cash Flow Statement

If your cash flow statement shows a net increase in cash, you have positive cash flow. If it shows negative net cash flow, you spent more cash than you brought in.

This isn't always a sign of trouble. For example, a company with large cash reserves might decide to reinvest heavily in the business, purchasing equipment that will help the company grow profits and generate more cash in the future. In that case, management expects significant cash outflows for the time period.

However, negative net cash isn't sustainable for viable for businesses in the long run. Ultimately, a business needs cash to pay employees, bills, and debts and return a profit to owners or investors.

Other reasons a company might have a negative cash flow include:

  • Low profits due to not charging enough for products and services or not controlling expenses
  • Spending too much on non-essential projects or initiatives that drain cash and don't boost profits
  • Unexpected expenses that weren't accounted for in your cash forecast
  • Late paying customers

If you prepare a cash flow statement and unexpectedly discover your company had negative cash flow, you want to ensure you understand why your cash payments are higher than your cash receipts and make changes to turn the trend around. If you don't, prolonged negative cash flow can threaten your business's success and sustainability.

Likewise, a positive cash flow isn't always a sign that the company is operating efficiently. For example, a company might have a positive cash flow but be hoarding cash. Investors might be unwilling to invest in the business because they think the money would be better put to work by reinvesting in long-term assets. Hoarding cash could also be a sign that the company isn't distributing profits to shareholders in the form of dividends.

A company might also have positive cash flow from taking on debt or selling off assets. So it's crucial to understand the company's goals and even look at trends in the sources and uses of cash over time to see whether the company is profitable and growing.

Looking at month-over-month and year-over-year cash flow trends can help you figure out:

  • When the business is likely to have a cash surplus or a cash shortfall
  • What the company does with excess cash when it's available
  • How the company handles a cash shortfall
  • Whether previous investments are performing as expected

Analyzing the Statement of Cash Flows: An Example

To help you understand how to interpret a statement of cash flows, let's consider a real-world example. In Apple, Inc.'s 2021 financial statements, the statement of cash flows shows the following:

Year Ended September 25, 2021Year ended September 25, 2020
Cash generated by operating activities$104,038,000$80,674,000
Cash used in investing activities$(14,545,000)$(4,289)
Cash used in financing activities$(93,353,000)$(86,820,000)
Decrease in cash, cash equivalents and restricted cash$(3,860,000)$(10,435,000)

If you were to look only at Apple’s total decrease in cash for the 2021 and 2020 fiscal years, it might look like the company is struggling because both years show a significant reduction in the company’s cash balance. 

However, a closer look shows how the company is using its cash. For example, the operating activities section shows Apple generated over $104 million in cash from its core operations. Meanwhile, the financing activities section shows the company spent nearly $86 million repurchasing common stock.

There are many reasons a company might repurchase its own stock. For example, it might do this to create value for shareholders, reduce its overall cost of capital, or improve its earnings per share. Whatever Apple’s reason for spending cash on stock buybacks, it’s clear that Apple’s negative cash flow in 2021 wasn’t due to a decline in market demand for its products or the company spending more than it was making. 

Conclusion

Whether you're a small business owner, a C-suite executive, or an investor, knowing how to create and interpret a cash flow is essential because it provides detailed information on how the company makes and spends its cash. When you understand this, you can make better, more informed decisions about how to run and grow your company or where to invest your money.

Michael Whitmire
As CEO and Co-Founder, Mike leads FloQast’s corporate vision, strategy and execution. Prior to founding FloQast, he managed the accounting team at Cornerstone OnDemand, a SaaS company in Los Angeles. He began his career at Ernst & Young in Los Angeles where he performed public company audits, opening balance sheet audits, cash to GAAP restatements, compilation reviews, international reporting, merger and acquisition audits and SOX compliance testing. He holds a Bachelor’s degree in Accounting from Syracuse University.

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