Understanding Cash Flow Statement: Definition, Calculation, and Examples
How to manage your business cash flow.
Please note that this article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or health & safety advice. For guidance or advice specific to your business, consult with a qualified professional.
A company’s cash flow statement is an integral document providing in-depth insight into a business’ operations, finances and investments. Due to it being so extensive in nature, cash flow statements can get a little complicated. That’s why we’ve outlined a thorough definition of what a cash flow statement entails, with examples and analysis tips to boot.
What is a Cash Flow Statement?
A cash flow statement is a document detailing all accumulated data reflecting cash coming in (inflow) from sales, investments and operations, as well as all the money going out (outflow), be it via purchasing stock, investing in equipment or a number of other business activities.
Importance of Cash Flow Statements in Business
A business’ cash flow statement can have a huge impact on a company’s budgeting and future financial plans. It tracks and details all the money coming in and out, meaning it gives a strong indication of a business’s financial future – both short-term and long-term. It can inform a company’s decisions regarding budgeting. For example, if business leaders identify an imbalance with more money going out than in, they may decide to cut down excess spending and prioritise core operations. Equally, if there are large amounts of money coming in proportional to outflow, they may decide now is a good time to invest and scale up.
Key Elements of a Cash Flow Statement
The three key elements of a cash flow statement are cash flow from operations, cash flow from investing, and cash flow from financing. These are described in detail below.
Operating activities in cash flow statement
This section of the cash flow statement notes cash inflow and outflow from operations that are reported on an accrual basis – i.e. when transactions take place but before real money is exchanged. Subsections of this part of the document include accounts payable, accounts receivable and income taxes.
Operating activities examples
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Employee salaries
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Vendors and supplier payments
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Customer payments
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Income received through interest and dividends
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Interest paid on loans
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Income tax
Investing activities in cash flow statement
As the name suggests, this section notes cash inflow and outflow from investments, including capital expenditures – the money a company invests in buying or upgrading premises and equipment – as well as sales of any fixed assets such as vehicles, warehouses or land. If relevant, this section will also detail expenditure relating to business acquisitions and the buying of investment securities.
Investing activities examples
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Buying fixed assets
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Investing in stock or securities
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Money lending
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Selling of fixed assets
Financing activities in cash flow statement
This section records debt and equity transactions. This includes the payment of dividends, the buying and selling of stock as well as bonds. Cash inflow from loans and the debt repayments are also noted here.
Financing activities examples
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Cash from purchasing and selling stock
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Purchasing shares
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Cash inflow from loans or repaying debt
Cash Flow Statement Example: Analysing a Company’s Financial Health
Below is a fictional example of a cash flow statement.
| Statement of Cash Flow for the year ended 31 December, 2023 | |
|---|---|
| Cash flows from operating activities | £230,000 |
| Net income | |
| Depreciation and amortisation | 63,000 |
| Loss on sale of equipment | 15,000 |
| Increase in accounts receivable | (21,000) |
| Decrease in prepaid expenses | 3,000 |
| Decrease in accounts payable | (28,000) |
| Net cash provided by operating activities | 262,000 |
| Cash flow from investing activities | |
| Capital expenditures | (300,000) |
| Proceeds from sale of equipment | 40,000 |
| Net cash provided by investing activities | 260,000 |
| Cash flow from financing activities | |
| Proceeds from issuing debt | 200,000 |
| Dividends paid | (110,000) |
| Net cash provided by financing activities | 90,000 |
| Net increase in cash over the year | 92,000 |
| Cash at the beginning of the year | 101,000 |
| Cash at the end of the year | £193,000 |
| Notes to the financial statement |
Interpreting the Numbers on a Cash Flow Statement
The heading of the cash flow statement tells the reader that the document refers to cash inflow and outflow for the year 1 January to 31 December, 2023.
Three subheadings indicate the three different sections: Operating activities, Investing activities and Financing activities.
The amounts shown in brackets, e.g. (300,000) under ‘Investing activities’ shows that this is a cash figure that was paid out. Brackets can therefore be seen as indicating a negative cash balance.
Conversely, amounts shown without brackets indicate cash inflow. They can therefore be seen as reflecting a positive cash balance.
Net cash recorded at the bottom of each subsection refers to the total cash used for that activity (operating, financial or investing). The ‘Net increase in cash during the year’ is the aggregation of each suction’s net cash recording. The net increase/decrease in cash during the year is added to the cash at the beginning of the year to show the end-of-year balance.
Finally, right at the bottom of the document ‘Notes to the financial statement’ tells the reader to look at the accompanying notes for more detail on the company’s transactions.
How Cash Flow is Calculated: Direct and Indirect Methods
There are two different methods used to prepare a cash flow statement: direct and indirect. The differences between the two are outlined below.
The Direct Method of Preparing a Cash Flow Statement
The direct method – also known as the income statement method – uses actual cash inflow and outflow in the company’s operations section instead of accrual accounting, or transactions that precede the exchange of cash. In other words, in the direct method, the statement will note when cash is received from a customer, not when the sale or transaction takes place.
The Indirect Method of Preparing a Cash Flow Statement
The indirect method, meanwhile, calculates cash flow using transactions rather than actual cash. That is to say, it uses accrual basis accounting for its calculations.
Advantages and Limitations of Cash Flow Statements
While cash flow statements are integral to providing an overview of a company’s finances, it does have their shortcomings when it comes to painting a full picture. Below are the advantages and limitations of generating cash flow statements.
Advantages of Cash Flow Statements
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Monitor performance - A cash flow statement can give business leaders a clear and concise way to evaluate their company’s performance by comparing the statement to projections.
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Track spending - Cash flow statements provide clear recordings of payments going in and out of a company, making it easy to keep track of.
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Improve financial planning - A cash flow statement can be a vital tool for informing financial strategies and plans, both long-term and short-term.
Limitations of Cash Flow Statements
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Doesn’t indicate liquidity or solvency position - One of the main weaknesses of a cash flow statement is that it only presents a company’s cash position at the end of one monthly, quarterly or annual period and therefore cannot be used to give a complete picture of a business’ liquidity.
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Is not the be all and end all of a company’s financial position - In and of itself, a cash flow statement provides more of a broad overview rather than a detailed insight into a business’ financial position. For a more complete picture, it should be viewed in conjunction with an income statement and balance sheet.
Tips for Analysing Cash Flow Statements
Understanding Changes in Cash Flow over Time
Your annual cash flow statement will look different year on year. For companies just starting out, it’s possible that the statement will reflect negative cash flow from operations due to high initial costs, growth investments and a delay in getting sales off the ground. This is not a huge concern as long as it is temporary as a company cannot sustain negative cash flow in the long term.
Eventually, over time, cash flow from operations must become positive in order to keep a business going. Comparing your cash flow statement year to year will help you identify problems, such as a dip in sales or an upshoot in debt.
Comparing Cash Flow Statements of Different Companies
You may find it useful to compare your cash flow statement to other comparable companies in the same industry. This can help you gauge how well you are performing compared to your competitors. While small entities are not required to publish their cash flow statements, medium to large companies are. This means you can easily access and view a number of businesses’ cash flow statements to compare to your own.
Conclusion: Understanding the Importance of Cash Flow Statements
Cash flow statements are hugely important when it comes to a company’s financial analysis across 3 key sections: operating, finance and investments. It’s, therefore, an essential component of good accounting practice and should be calculated annually to give business leaders a clear picture of their company’s financial performance and inform future financial forecasts.
Frequently asked questions
Cash flow is the money that moves in and out of a business. Staying on top of your cash flow is a vital part of running a successful business – and an accurate cash flow statement is a key tool for achieving this. You can use your cash flow statement to make sure your business has enough money coming in to pay off any debts and to fund day-to-day running expenses.
As a general rule of thumb, a rolling monthly cash flow statement should help you stay in control of your business’ performance. Ideally, you’d also have an idea of what your cash flow will look like over the next 12 months. That way, you can anticipate any potential problems and quickly nip them in the bud.
The solution to your cash flow problems will vary depending on what the exact sticking point is. There are some early warning signs you can look out for so you’re not surprised by cash flow problems. These warning signs include: relying too heavily on one particular client, lots of short-term debt and too much stock combined with flagging sales.
To keep cash flowing in, you should send your invoices out quickly and with clear deadlines for payment. Use Square’s online invoicing tools to instantly send invoices and monitor payments. This makes it easy to keep track of what’s been paid and what’s still outstanding.
Keep the customer’s journey as smooth as possible and ensure there are no sticking points standing in the way of accepting payment, whether through your online store or a physical point-of-sale.
Cash flow from operating activities describes funds that contribute to the running of your business. These come from sales you’ve made. Cash from investing activities is the money spent on assets, such as equipment or loans. Finally, cash from financing activities covers money received from investors and banks.
A balance sheet shows the summary of a company’s financial balances. It provided a snapshot of how much a business owns and owes at a particular moment in time. A cash flow statement, meanwhile, indicates changes in balance sheet accounts as well as income, giving a more overall picture of a company’s financial position.
Cash flow statements reveal what state and stage a business is in. That is, whether it’s just starting out, rapidly growing or a mature and already profitable organisation. It may also indicate that a company is in a period of transition or in steady or rapid decline. In the case of the latter, a cash flow statement can be analysed along with other financial reports to identify areas where the cash situation can be improved, e.g. through downsizing and cutting costs
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