Cash Flow Statements Explained

• A cash flow statement outlines how cash moves in and out of your business, allowing you to easily track how money is spent and the sources of cash received.
• This statement is key in maintaining your business’s cash position, ability to execute its day-to-day operations, as well as growing your business with outside investors.
• It consists of three sections: cash flow from operating activities, investing activities and financing activities.

Running a successful business means keeping an eye on your company's cash management. And as a business owner, managing your cash can help you pay bills in a timely fashion, better understand your business's working capital and stay financially solvent. A cash flow statement is an essential tool to help you do these things.

Understanding cash flow statements canhelp you make more informed decisions about your company’s spending and to secure financing. Read on to learn what a cash flow statement is, how to read them and how to use them to guide your business’s growth.

What is a cash flow statement?

A cash flow statement, or statement of cash flows, is a report that outlines how cash and cash equivalents enter and exit a business. Cash flow is different from net income, which demonstrates how much profit a company has earned for a specific period of time.

Cash typically comes in from sales, proceeds from investments, and from investors or financial institutions. Cash exiting the business includes expenses, like payroll and income tax payments, cash paid for investments and payments to investors or financial institutions.

A good cash flow statement summarizes every cash transaction flowing in or out of the business. It contains three sections: cash flow from operating activities, investing activities and financing activities.

The statement is compiled regularly: monthly, quarterly, annually or some combination of the three, using the direct method or indirect method. It’s just one of several essential reports you need to assess your company’s financial health. In fact, many businesses have been obligated to create them since the late 1980s under the generally accepted accounting principles (GAAP) in the U.S.

Cash flow statement format

The cash flow statement format includes three sections, and you’ll need to understand each to read and interpret the report. Together, the three sections provide a snapshot of how money is being used in the business over a period of time.

Cash flow from operating activities

The operating section in a cash flow statement outlines how cash moves in and out of the business as a result of its day-to-day operations. Transactions in this section include:

• Sales of goods or services
• Service and supply expenses
• Payroll
• Interest payments
• Accounts payable fluctuations
• Accounts receivable fluctuations
• Depreciation and amortization
• Current assets
• Current liabilities
• Other day-to-day expenses

Cash flow from investing activities

This section outlines how cash transactions through the sale and purchase of investments and long-term assets. If a company purchases or sells an equity investment of another entity, this could be considered an investment.

Cash flow from financing activities

The final activities section outlines cash transfers due to financing. This can include cash received from investors or paid out to shareholders, money received from a loan or a line of credit, money used for debt repayment or stock repurchases.

How to prepare a statement of cash flows

There are two primary ways to prepare a statement of cash flows: the direct method and the indirect method.

In the direct method, one simply sums the total cash coming in and going out of the business. It can work better for small businesses with fewer transactions to track and is compatible with the cash basis accounting method.

The indirect method, meanwhile, involves making adjustments to a business’s net income by accounting for the noncash expenses, such as depreciation and amortization. This is particularly important for businesses using accrual basis accounting, which heeds noncash items. Since accrual accounting recognizes revenue when earned in addition to cash receipts and cash payments, it won’t be an accurate marker of a company’s cash flow without further financial analysis and computation from one accounting period to the next.

Speak with your accountant about which cash flow statement method will work best for your company — and then you can learn to calculate cash flow yourself.

Cash flow statement example

Below is a simple template of a cash flow statement. Keep in mind: Your company may have different line items. Numbers presented plainly represent positive cash coming into the company; numbers in parentheses signify negative cash flow going out of the company.

How to read a cash flow statement

Once you have calculated all three sections of the cash flow statement separately and then together, you will end up with either a positive or negative result. Here’s what each means.

A positive cash flow indicates that the company has more cash coming in than going out. But that isn’t necessarily a good thing if you look beyond the surface: Taking out small business loans, for instance, adds value to a company’s cash flow in the financing activities section, because it’s categorized as incoming money. If a company goes deep into debt over its loans, it might find itself in financial straits while still maintaining a positive cash flow.

A negative cash flow, conversely, means that more money is going out than coming in. While that could certainly indicate problems in the long run, short-term negative cash flow is often consistent with early-stage businesses getting off the ground. In fact, many startups use negative cash flow to track their burn rate to forecast when their operations will become profitable.

Why are cash flow statements important?

The importance of cash flow statements runs deeper than being a mandatory requirement for certain companies in the United States: They have several benefits for both business owners and investors.

For business owners, cash flow statements provide insight into your business’s liquidity, cash balance and future cash flow projections. With this information, you can assess your ability to make new purchases or investments, set budgets and optimize your earning procedures in the short and long term.

Preparing and analyzing a business’s cash flow statements can also help business owners identify issues that might be inhibiting cash flow. Overall, cash flow statements can help business owners determine whether their business has sufficient cash flow to manage their debts and other expenses.

For investors and lenders, a cash flow statement  — together with other key financial documents — is crucial in assessing a business’s financial health and making informed decisions about investing and lending activities.

Understanding cash flow reports

Understanding cash flow statements, as well as cash flow as a general concept, can make it easier to gauge the financial health of your business. A strong understanding of your business’s cash flow can also help when you start seeking financing, as cash flow statements are one of several documents investors and banks will use to evaluate your business.

Continuing to learn about small business accounting and small business bookkeeping can help you feel more confident and decisive in your business finances, and so can finding a reliable banking partner.