skip to Main Content

Log in to your customer dashboard or Partner Portal using the links below

What Is a Cash Flow Statement? A Short Guide for Small Business

Image of a person analysing a cash flow statement

A cash flow statement is one of three financial statements that are crucial for any organisation. The other two are the income statement and balance sheet. Here we’ll take a closer look at the cash flow statement and how it works.

What is a cash flow statement?

A cash flow statement (or statement of cash flows) is a financial statement that provides a summary of how cash and cash equivalents are entering or leaving a business.

It’s primarily used to gauge how well a company is doing in generating cash and maintaining its revenue. This financial reporting document shows if a firm is getting enough cash to pay debts and cover its operational expenses. The cash flow statement complements the income statement and balance sheet.

How can you use a cash flow statement?

The cash flow statement is an essential document which people use in several ways to understand a company’s financial condition. It shows how cash flows from operations or operating activities or how cash flows from financing. Here are some ways companies use this document:

  • Investors use cash flow statements to understand how a company is operating. They can see how the company is getting money and how it is spending the funds they’re receiving. Using this statement, investors can see if a firm is doing well and if its financial footing is solid.
  • Creditors also use this financial document to understand how much cash (liquidity) a company has on hand. They try to determine if the business has sufficient funds to meet expenses and repay debt.

Structure of a cash flow statement

Here are the crucial components that form the cash flow statement:

  • Cash flows from operating activities
  • Cash flows from investing activities
  • Cash flows from financing activities
  • Disclosure of non-cash transactions or activities is sometimes listed down in this statement.

Many people get confused with the three financial statements. They think they are interlinked and similar. In reality, all these statements are different from each other. The reasons why the cash flow statement is distinct from the other two financial statements is because it doesn’t include the amounts of outgoing cash and future incoming cash, which they usually record under credit.

Because of this, cash is not equivalent to ‘net income’. Whereas the balance sheet and income statement report cash sales and sales on credit where the customer will pay in a short time, usually 30 days.  

Operating activities

On the cash flow statement, operating activities are both the sources and uses of cash that come from conducting business activities. In a nutshell, it indicates how much money a company generates by selling its products or services.

Here are the components or cash items that you can include in the operating activities:

  • Interest payments
  • Cash receipts from sales of goods or services
  • Rent payments
  • Payments to suppliers who supply goods or services used in production
  • Wage or salary payments to the employees
  • Income tax payments.

Components such as accounts receivable, changes in cash holdings, inventory, accounts payable and depreciation are included in cash from operations.  

If a company has investments or a trading portfolio, these companies can include receipts like the sale of loan or debt, and equity instruments.

If an organisation is using an indirect method to prepare a cash flow statement, they can also include the following in it:

  • Amortisation
  • Deferred tax
  • Depreciation
  • Gains or losses that come from noncurrent assets
  • Revenue or dividends you receive from investment activities.

Companies may, however, not include sales or purchases of long-term assets under operating activities.

Calculating a cash flow statement

Finance teams calculate and prepare cash flow statements by making the necessary adjustments to net income by either adding or deducting the differences in revenue, credit transactions, and cash expenses (which appear on the balance sheet and income statement) that are the results of the transactions that occurred during a specific period.

They make these adjustments as non-cash items fall into net income (income statement) and under the total assets and liabilities (balance sheet). Since most of the transactions do not involve actual cash, finance teams re-evaluate most of the items when preparing the cash flow statement from operations.

Two methods for calculating cash flow: direct and indirect

There are two methods you can use to calculate cash flow – the direct method and the indirect method:

Using the direct method, you add up various types of receipts and cash payments, which also includes cash paid in salaries and cash receipts you have received from customers. You calculate these figures using the beginning as well as the ending balances from various business accounts apart from observing the net increase, as well as a decrease in these accounts. With this method, accounts receivable and accounts payable are not considered when calculating cash flow.

With the indirect method, you consider cash inflows from all operating activities which you take from net income from the income statement. Companies prepare the income statement on an accrual basis. When using accrual accounting, you recognise revenue as something that a company earns, regardless if payment has been received yet. The same applies to expenses, so accounts receivable and accounts payable are included in cash flow.

Investment activities

An investment activity indicates how a company uses its cash towards investment. Elements such as the purchase or sale of fixed assets or short term asset, new equipment, fall under this category. Cash out is a term used when a company buys buildings, new equipment, etc. Cash in is the term that they use to refer to when a company chooses to divest an asset.

Wrapping it up

By using a cash flow statement, you can understand a company’s profitability and strength. You can get a picture of what’s in store for a business in the future when it comes to cash flow. It will tell you if the company has sufficient funds to repay debts using liquid cash on hand. This financial document comes in handy when planning a budget.

You can download a cash flow statement template here.

To learn more about other important financial statements, see What Is a Balance Sheet? and What is An Income Statement?

Also, unsecured business lenders consider a company’s cash flow when making lending decisions. Find out more in What Is a Cash Flow Loan?

Author:

All the thoughts, ideas and musings from the Moula team! Covering everything from work/life balance to general finance tips plus everything in between!

Like it? Share it!

Get a repayment schedule

Close form panel

We’ll send the results to your inbox right now.

Email sent

Your email is on its way!

Something went wrong

Your repayment schedule email was not sent. Please call us on 1300 88 58 93 for assistance.