How To Prepare a Cash Flow Statement: Complete Guide

A business’s cash flow statement is a crucial document that reveals how well the business performs financially. It provides a detailed overview of all sources and uses of cash and an estimate of future cash requirements.

This post will briefly overview the different parts of a cash flow statement and explain why they’re so important. We’ll also provide tips on effectively using a cash flow statement to assess your business’s overall performance.

So whether you’re a beginner or an experienced business owner, this post is essential reading.

What Is A Cash Flow Statement?

A cash flow statement is a document that shows how well a business is performing financially. It provides a detailed overview of all sources and uses of cash, as well as an estimate of future cash requirements.

The different parts of the statement of cash flows include:

1. Cash inflows

   This section lists all the money that has come into the business during the reporting period (usually one month). This includes both incoming revenue (i.e., income received from customers) and outgoing payments (i.e., expenses made to suppliers or employees). The total amount listed in this section is known as net capital activity. 

2. Cash outflows

   This section lists all the money that has gone out of the business during the reporting period (usually one month). This includes both outgoing revenue (i.e., payments to customers, suppliers, or employees) and outgoing expenditures (i.e., costs associated with running the business, such as rent or advertising). The total amount listed in this section is known as net capital expenditure.

Importance Of A Cash Flow Statement

A good cash flow statement provides a detailed overview of all sources and uses of cash and an estimate of future cash requirements. You can assess your overall performance by understanding how much money the business is spending and earning each month.

There are a few key things to look for when reviewing a company’s financial data:

1. Networking

   Does the company have any ongoing debt obligations that need to be repaid? This could indicate high levels of risk in the long term (and potentially lead to bankruptcy). Also, is there anything unusual happening with accounts receivable or accounts payables that might point to problems?

2. Revenue and expenses

   Are revenue levels trending upwards or downwards? For example, this could indicate a problem with the company’s marketing strategy. Likewise, if expenses are outpacing income, this might indicate that too much spending is being done to make up for shortfalls in other areas (such as research & development).

3. Working capital

   How healthy is the business’ bank balance compared to its liabilities? A high working capital ratio signals that there may not be any major financial issues looming. Conversely, a low working capital ratio could soon point to potential cash flow problems.

4. Short-term planning

   Knowing how much cash a company plans to have available at all times is essential for making sound business decisions. A cash flow statement allows you to see the total amount of money the business has generated and spent each month and an estimate of future needs.

5. Insight into spending activities

   Examining a company’s spending patterns can help identify areas where costs may be inflated. This could be due to an over-ambitious marketing campaign, for example, or excessive waste in the production process.

6. Ability to increase cash inflow

   When assessing a company’s financial health, it is also important to consider its ability to increase cash inflow. This could be due to increased sales or investment from outside sources.

Understanding The 3 Components Of A Cash Flow Statement

A cash flow statement is composed of three components of a cash flow statement:

1. Operating activities
2. Investing activities
3. Financing activities

The three main elements of cash flow statement are explained in more detail below.

1. Operating Activities

   This section includes all of the expenses and cash outlays associated with running the business, such as salaries, rent, advertising costs, and other operating costs. Operating income (or loss) is calculated by subtracting these expenses from total revenue (or gain).

2. Investing Activities

   This is one of the main components of the cash flow statement. It covers all the money invested in your business over the past year or so – for example, money used to purchase new equipment or expand your operations. This includes money spent on developing new products or services, buying stock or investing in other businesses, and anything else that goes towards expanding your company’s reach.

3. Financing Activities

   This section covers all the money borrowed to support your business’s operations – for example, cash infusions received from investors during times of growth or loans repaid with interest. Financing income (or loss) is calculated by subtracting financing costs from total revenue (or gain).

How Do You Prepare A Cash Flow Statement?

Here are the 5 steps to follow for creating an efficient statement of cash flow for your business.

1. Step 1: Be decisive on your starting balance

   The first and foremost step to prepare an efficient  cash flow statement format is to be assured of the starting balance of your business cash right at the beginning of the reporting period.

   Well, your business starting balance can be found on your business’s income statement in the relevant accounting period.

2. Step 2: Evaluate your business operating cash flow 

   The next step would be judging the cash flow amount gained through the business’s operational activities.

   This is the most crucial step because it reveals the exact amount of cash your company generates through its operations. Methods for calculating operating cash flow are as follows:

   • Direct: It is a straightforward process where you must subtract cash disbursement from the total cash collected through the business operation.  
   • Indirect: In this method, you need to eliminate the accruals spent from the total income during the reporting period.

3. Step 3: Calculate your business investing cash flow 

   It is then time to examine your business’s cash inflows and outflows through financing activities. Here, cash inflows and outflows refer to the money raised and paid to the investors or creditors.

   Determining your business cash flow through financing activities will enable you to manage your business debt and equity levels better.

4. Step 4: Evaluate your business financing cash flow 

   The header section acts as an introduction to the client. Here, you include your name or your business name. This should be highlighted in a bigger font and different color. Below the name, include your contact details, website, email address, and other pertinent items.

5. Step 5: Settle your end balance

   Finally, once you have examined all the cash flow generated through those 3 main steps (examining operating, investing, and financing activities), you can determine your business ending balance for the reporting period.

   The difference between the net cash amount and the sum of cash flows obtained through those 3 steps tells you the amount of cash flow your business gained (positive cash flow) or lost (negative cash flow) during the reporting period.

How To Analyze A Company’s Financial Health Using a Cash Flow Statement?

Analyzing a company’s statement of cash flow is the first step in establishing its financial health. This document provides an overview of how much money the business has been able to bring in and use over the past year or so – information that can help you determine whether there are any problems with your company’s finances.

Cash flow statements are also useful for identifying areas of your business that are generating more (or less) revenue than others with the help of cash flow statement components. By looking at your operating income and financing expenses alongside your total revenue, you can see where improvements may need to be made – for example, by increasing advertising costs or cutting costs elsewhere in your company.

Other ways include:

1. Direct Cash Flow Method

   This is the most common method to calculate a company’s cash flow. It considers all sources and uses of cash, including customer receipts, payments for expenses (including interest and principal repayments), dividends paid to shareholders, and purchases of assets (such as new equipment).

2. Indirect Cash Flow Method

   This is a less common method that only considers direct cash flows (from customers, payments for expenses, and dividends paid to shareholders) – omitting purchases of assets. This may be more accurate if you’re primarily interested in measuring how much money your company has been able to bring in from its actual operations rather than investing activities.

Cash Flow Statement vs. Income Statement and Balance Sheet

The primary difference between a cash flow statement and other financial statements is that it measures how much money the company has been able to bring in (through its actual operations). In contrast, other financial statements measure how much money the company has been able to spend (on things like capital expenditures or dividends).

This can be important if you want to know whether your company is spending too much on interest or dividend payments, as these may indicate problems with your overall finances.

Another key difference between a cash flow statement and other financial statements is that a balance sheet shows what’s owned by the company (assets). In contrast, a cash flow statement shows both what’s owned by the company and how much money has been able to be brought in through actual operations.

This can help you see whether your company is generating enough cash to cover its bills and identify areas where more investment may be necessary.

8 Common Mistakes to Avoid when Reading a Cash Flow Statement

Here is the list of the top 8 mistakes businesses should avoid while calculating their cash flow.

1. Not understanding the difference between net income and cash flow

   Net income is a company’s total earnings (after taxes), while cash flow measures how much money can be brought in through actual operations. If your company has a lot of debt but is still generating positive cash flow, it may be doing well despite some budgeting challenges.

2. Ignoring nonrecurring expenses

   Nonrecurring expenses are any expenses that occur less than once per year. So items like rent or salaries for irregular work employees can influence a company’s cash flow. If a lot of nonrecurring expenses are driving up your overall cash flow, it may be worth considering cutting back on some of these costs in the future.

3. Focusing too much on one line item

   When analyzing a company’s financial performance, you’ll often want to focus on specific lines like profit or revenue – but don’t forget about other important indicators like cash flow and debt levels. By understanding all the components of a company’s finances, you can better understand its performance.

4. Not accounting for changes in currency exchange rates

   Currency exchange rates can play a major role in a company’s financial health, as different currencies may impact its bottom line differently. If your business is based overseas and takes advantage of currency fluctuations to make profits, be sure to track these movements regularly so you’re not surprised by large swings in your finances.

5. Not tracking inventory levels

   Inventory levels can also greatly affect a company’s cash flow – if too much inventory is sitting around waiting to be sold, that will eat into profits sooner rather than later. By keeping tabs on each department’s inventories, you can ensure that your company uses its resources as efficiently as possible.

6. Not factoring in maintenance and marketing costs

   Even if a company’s profits are stable, it may still need to allocate some funds toward ongoing maintenance or marketing efforts. If these expenses are included in your analysis, you may be aware of key factors that could impact the long-term health of your business.

7. Not taking into account taxes

   Taxes are always an important factor to consider when looking at any financial data, as they can significantly impact how much money a company makes. By regularly tracking your company’s tax liabilities and receipts, you can ensure that your finances remain on good footing regardless of the economy.

8. Not factoring in debt repayment

   Even if a company is making profits, it may still need to pay back debts incurred over the past few years. If you’re not tracking your assets and liabilities carefully, you could end up in serious trouble.

Cash Flow Statement Example 

Below is a cash flow statement example. Look at the image, which shows the amount of money a company has in each category during the reporting time.

Well, the image gives the complete cash details. As of the image, the company’s net cash flow during the FY 2018 was $2,528,000.

Source: Zoho

1. Operating Activities

   Subtracting the outgoing cash from the incoming cash ($3,018,000 – $3,000,000) = $18,000 

   Since the net value of the operating activities comes in positive, it is a good sign.

2. Investing activities

   The company invested $500,000 in purchasing investment which is negative from the generated income through operating activities. 

   However, it doesn’t mean it is bad for business. It shows the company has enough potential to invest for its growth.

3. Financing activities

   As for the image values, the company still has $10,000 to cover the debt. 

   However, despite that $10k as notes payable, the company still has plenty of cash flow which is a good sign.

4. Net cash flow

   To calculate the net cash flow, you need to add all the values obtained on 3 main activities.

   Net Cash Flow -> 3,018,000 + (-500,000) + 10000 = $2,528,000

   This clearly shows the company has enough money to carry out its operations without hassle.

In Conclusion

Understanding the cash flow statement is essential for businesses of all sizes. By understanding how cash is moving through your business, you can better manage your resources and ensure that your finances are in good shape.

By understanding what a cash flow statement is, where your cash is coming from, and where it’s going, you can make informed decisions about where to allocate your resources and ensure that you are efficiently running your business.

In addition, a strong statement of cash flow can indicate that your business is healthy and financially sound – making it an attractive prospect for potential investors.

Check out our blog if you’re interested in learning more about the cash flow statement format. We will provide detailed explanations and examples to help you understand this important financial document.