Cash flow statements are one of the key financial reports that business leaders depend on to assess their company’s financial health. Knowing how to prepare a cash flow statement alongside income statements and balance sheets provides essential insights into cash inflows and outflows, offering a clear view of a company’s cash movement. Although all three financial statements are crucial, many believe that cash flow statements give the most straightforward snapshot of a business’s liquidity and stability.
Business owners, managers, and stakeholders use cash flow statements to understand their company’s financial stability and make informed choices. Learning to create and explain these statements is valuable for anyone looking to understand their company’s finances and support its growth.
At SAS KPO Services, our outsourcing team can assist with clear and accurate cash flow management, so you can stay focused on what truly matters—growing your business.
What is a Cash Flow Statement?
A cash flow statement is a financial report that shows all the cash moving in and out of a business within a certain time frame. It records the cash a company earns from its daily operations, investments, and financing activities, as well as where it spends that cash, whether on regular business expenses or larger investments.
For investors and analysts, the cash flow statement gives a clear picture of a company’s cash health, helping them understand all the financial transactions that keep the business running. It’s often considered the most straightforward financial statement because it simply tracks cash coming in and going out in three main areas:
Operating Activities:
Cash generated from everyday business operations, like selling goods or services, and the expenses involved.
Investing Activities:
Cash spent on or earned from long-term assets, like property or patents, paid for with available cash (not debt).
Financing Activities:
Cash from borrowing money or issuing stock and payments related to these financing sources.
When combined, the cash from these three areas is known as “net cash flow.” This total provides a clear view of the company’s financial position, helping to assess its overall value and stability.
Steps to Create a Cash Flow Statement
Creating a cash flow statement can be simplified by following these steps:
Set Your Time Period and Choose a Method:
Decide on the period your cash flow statement will cover—quarterly, semiannually, or annually—based on your business needs. Select either the direct method, which includes all cash receipts and payments, or the indirect method, which adjusts net income using non-cash changes from the balance sheet.
Gather Essential Financial Documents:
Collect all key financial documents like income statements, balance sheets, and equity statements. Review past cash flow statements, check all cash, and bank account ledgers to ensure accuracy.
Calculate Changes from the Balance Sheet:
Determine the changes in opening and closing balances on your balance sheet, ensuring they total zero for accurate reflection. For example, record any machinery purchases as an investment activity to show how they affect cash flow.
Record Non-Cash Transactions:
Include all non-cash expenses, such as depreciation and bad debts, to adjust net income. These adjustments reflect the actual cash flow and give a clearer financial picture.
Organise Cash Flow into Three Sections:
Once all data is collected, complete the sections for operating, investing, and financing activities. A positive cash flow balance indicates strong financial health, while a negative balance suggests more cash going out, often due to high investments or expenses that may require cash inflows.
Following these steps makes prepare a cash flow statement easy, offering valuable insights into your company’s cash management and financial well-being.
Sources of Cash Flow Statements
When you’re looking to understand how to prepare a cash flow statement, there are a few methods you can use. If you handle your own bookkeeping in Excel, you can generate cash flow statements monthly by pulling data from your income statements and balance sheets. Alternatively, if you use accounting software, it can automatically create a cash flow statement for you based on the information entered into the general ledger.
However, remember that your cash flow statement will only be accurate if your overall bookkeeping is correct. For the most reliable cash flow statement, hiring a professional bookkeeper can ensure that everything is accounted for properly. A bookkeeper will keep track of your financial data, helping you stay on top of your company’s financial health.
The Importance of Cash Flow Statements for Business Success
Cash flow statements are essential for any business that uses accrual accounting. They provide valuable insights into your company’s financial health and are crucial for making informed decisions. Here’s why cash flow statements are so important:
They Show Your Liquidity:
Cash flow statements help you understand how much cash is available for day-to-day operations. Knowing your liquidity allows you to make decisions about what you can afford and what you can’t, ensuring you never run into cash shortages.
They Reflect Changes in Assets, Liabilities, and Equity:
A cash flow statement tracks changes in your business’s assets, liabilities, and equity. This provides a clear picture of your financial performance and helps you understand how money is flowing through your business.
They Help You Predict Future Cash Flows:
By analysing your current and past cash flows, you can create projections for future cash availability. This is critical for planning your long-term business strategy and ensuring you have enough liquidity to meet future needs.
Support Loan and Credit Applications:
If you’re applying for a loan or line of credit, up-to-date cash flow statements are often required. Lenders depend on these statements to assess your business’s ability to repay the loan and manage cash efficiently.
Aid in Financial Planning and Budgeting:
Cash flow statements are key for both short-term and long-term financial planning. They help you set realistic budgets, track spending, and adjust to meet specific financial goals.
Prioritise Business Activities:
Management analyses cash flow to determine which activities are essential for business success and which ones may need adjustment or elimination. This allows businesses to focus on areas that will drive growth and reduce wasteful spending.
Optimise Cash Use and Working Capital:
A well-prepared cash flow statement helps businesses understand how to use their cash most effectively, identify areas where they can improve efficiency, and determine the right level of working capital to meet obligations.
When you learn how to prepare a cash flow statement, you gain a valuable tool for making informed business decisions, tracking financial health, and ensuring your business stays on track for future success.
Cash flow statements are not just a snapshot of your finances; they are a necessary resource for understanding your business’s strengths, weaknesses, and opportunities for growth. With clear insights into your cash position, you can confidently navigate challenges and plan for the future.
Breaking Down the Three Main Sections of a Cash Flow Statement
A cash flow statement is a crucial financial document that shows how cash moves in and out of your business. It’s divided into three primary sections, each helping to explain where your company’s cash comes from and where it’s going. Understanding these sections can give you valuable insights into your business’s financial health.
Cash Flow from Operating Activities:
This section tracks the cash generated or spent from your regular business operations—how your business earns money through selling goods or services. Any payments you receive from customers for products or services fall into this category. On the other hand, cash outflows related to day-to-day operations, such as paying salaries, rent, and utilities, are also recorded here. This section reflects the primary activities that keep your business running and growing.
Cash Flow from Investing Activities:
Investing activities involve cash transactions related to buying or selling long-term assets. This can include purchases of property, equipment, or other investments that help your business grow or operate more efficiently. If you sell equipment or other investments, the cash you receive from those transactions also appears in this section. This section helps you track how your business is investing for its future.
Cash Flow from Financing Activities:
This section focuses on cash flows related to how your business is financed—whether through borrowing, issuing shares, or raising money from investors. Loans or equity financing record their cash inflows here. You record cash outflows here when repaying loans or distributing dividends to shareholders. This section provides insights into how your business funds its operations and growth through external sources.
By examining each of these three sections—operating, investing, and financing activities, you can understand the full picture of how cash is moving in and out of your business. It helps you see how well your company is managing its day-to-day activities, investing in the future, and handling its financial obligations.
The Bottom Line
knowing how to prepare a cash flow statement is an essential skill for any business, as it offers valuable insights into your company’s liquidity, financial health, and future planning. It helps you manage cash flow, make informed decisions, and plan for growth while ensuring that your business remains financially stable. By understanding and utilising the three main sections—operating, investing, and financing activities, you can gain a clear understanding of your cash movement and overall financial performance.
Connect with SAS:
If you need expert assistance in creating accurate cash flow statements and managing your financial records, SAS is here to help. Our experienced outsourcing team can handle your financial reporting, allowing you to focus on growing your business. Contact us today to learn how we can support your financial management needs.
FAQ-
No, profit is different from cash flow. Profit is what’s left after subtracting all expenses from revenue, often called net income.
Cash flow, on the other hand, is about the actual movement of money in and out of a business. A business has positive cash flow when more money is coming in than going out, and negative cash flow when it’s the opposite.
While profit shows how much a business earns, cash flow focuses on how well it manages its money day-to-day. Both are important for understanding a company’s financial health, but they measure different things.
Cash flow can be calculated using different formulas depending on the type of cash flow.
Free Cash Flow (FCF) –
This formula shows how much cash is left after covering major expenses:
Free Cash Flow = Net Income + Depreciation/Amortisation – Change in Working Capital – Capital Expenditures
Operating Cash Flow (OCF) –
This formula concentrates on the money made by day-to-day operations:
Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital
These formulas help businesses understand how money moves in and out, ensuring they have enough cash for growth and expenses.
A good operating cash flow margin is over 50%. This shows that the business is efficiently converting sales into cash. If the margin falls below 50%, it might mean the company is struggling with high expenses, which affects its ability to generate cash.