Cash Flow Statement: A Short Guide for SMEs

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. These are also known as cash inflows and cash outflows. 

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 (CF) statement complements the income statement and balance sheet.

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 CF 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.

Learn more from What Is Cash Flow?

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 CF 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.  

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 CF 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.

Accountants calculate and prepare statements of cash flows 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) resulting from 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, accountants re-evaluate most of the items when preparing the cash flow statement from operations.

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.

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. 

Depending on the type of transaction, changes in cash flow can influence working capital. For example, if a business purchases a fixed asset, such as an office building, its cash flow would decrease. The working capital of the business would also decrease because the cash portion of current assets would decrease.

If the business buys inventory with cash, there would be no change in working capital because inventory and cash are both classified as current assets. Cash flow, however, would be lower as a result of the inventory purchases.

Learn more in Working Capital: What Is It and Why Is It Essential for Small Business?

By using a statement of cash flows, 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? and What Is Cash Flow Finance?