As a business owner, understanding what money you have available and how you’re spending it is crucial. External stakeholders like investors and creditors want to know how you spend your capital.
Internally, understanding cash flow helps you better manage cash, forecast operations, and determine where to put your resources. With a process in place to automate your financial statements and prepare a cash flow statement, it’s easier to track your cash and gain helpful insights.
Cash flow statement definition
A cash flow statement is an important financial tool showing the amount of cash and cash equivalents you have available at the end of an accounting period. You can prepare your statement of cash flows monthly, quarterly, or yearly. It basically answers the question, “How well are you managing cash?
As one of the three core financial statements, along with the balance sheet and income statement, the cash flow statement helps establish a clear picture of your company’s cash flow.
3 types of cash flows
The cash flow statement reveals positive cash flow and negative cash flow—in other words, the cash flow for a specified accounting period.
But to better understand cash flow statements, let’s take a closer look at its three key components: operating activities, investing activities, and financing activities.
1. Operating activities
This part of the cash flow statement represents how much cash is generated by the business’ core operations, like paying salaries and rent, buying inventory, and paying income taxes. Investments, dividends, and debts are not part of this section.
2. Investing activities
Investing activities include cash flow from selling or purchasing different long-term assets including physical property (think real estate) or non-physical items (think patents).
3. Financing activities
The cash flow statement also details the extent of cash flow coming from debt and equity. Financing activities include issuing or paying down debt, paying cash dividends, and issuing or selling stock.
Cash flow statement example
Now that you know what a cash flow statement is, let’s take a look at a cash flow statement example.
As you can see, a cash flow statement includes sections for operating, investing, and financing activities. The way it’s organized, you can see net cash flow for each type of activity, as well as the total end-of-period amount. At the end, you’ll have a concrete view of the cash you have on hand at the end of the period as well as an overview of cash flow activities during that time frame.
By comparing your cash flow statements over time, you can see how well your business manages its cash position. This gives you another window into your financial performance, in addition to what you learn from your income statement and other important financial reports.
How to prepare a cash flow statement
There are two different methods for calculating cash flow: the direct method and the indirect method.
The indirect method and direct method are two approaches used to prepare the operating activities section of the cash flow statement. The process for preparing the investing and financing sections is the same, whichever method you choose.
While both methods ultimately arrive at the same net cash flow from operating activities, they differ in how they present the information.
1. Direct method
The direct method calculation considers all cash collections coming from operating activities and subtracts the cash disbursements for operating activities. The result is net cash from (or net cash used by) operating activities.
Download our direct cash flow template to get started using the direct cash flow method.
2. Indirect method
The other way to prepare the statement of cash flows starts with net income from the income statement. It then adds adjustments as necessary to “undo” the impact of non-cash transactions affecting net income.
For example, you add back depreciation and amortization expense, as these are non-cash expenses. You also adjust for any changes to accounts payable, accounts receivable, prepaid expenses, and accruals. Once you remove all non-cash transactions, the result is your net cash from (or used by) operating activities.
When you create your cash flow statement and calculate your cash inflows and cash outflows, you can also create a cash flow budget. This type of budget helps you plan for available cash. It’s a practical tool to use with other budgeting methods that focus on profit only.
Download our indirect cash flow template to get started using the indirect cash flow method.
How to use a cash flow statement
You can use a cash flow statement to help with internal budgeting decisions and hiring decisions. It shows what you can and cannot afford and reveals whether you’re generating cash from operations or propping up cash flow with inflows from loans or shareholder contributions.
Another use is projecting what will happen in the future because you can use your cash flow statements to predict future cash flows.
Investors and lenders look at the cash flow to determine if the company is risky—so having positive cash flow can help you qualify for loans or attract outside investors, which supports business growth.
How cash flow statements can help your business thrive
Here’s the thing: your business won’t be sustainable without cash flow.
With the cash flow statement, you gain a better understanding of how and when to pay back loans, purchase equipment or inventory, or give shareholders a return on their investment. Keeping an eye on cash flow allows you to avoid slipping into negative cash flow territory where you can’t keep the lights on, meet payroll, or service your debts.
Here are some of the other advantages of a cash flow statement:
- Gain insights into spending habits: With cash flow statements, you quickly understand whether your operations are generating or consuming cash. If your cash flow from operations is negative, you may need to rein in your expenses.
- Maintain a cash balance: Having cash sitting around is not ideal, but running out of the cash you need to pay the bills isn’t a good idea, either. When you understand how much cash you need to maintain operations, you can invest excess cash to generate profitable returns. And if you’re short on cash, you can apply for a loan or line of credit to keep your business going.
- Plan better: Better financial planning = better financial outcomes. A successful business typically has liquid cash to pay off debts, such as short-term liabilities, with future payments. With your past cash history, you can analyze past transactional data to make better decisions about paying off debts or requesting a higher credit line, if necessary.
- Generate cash: You need to generate cash to increase profits. For example, running a clearance sale to get rid of stale inventory is a way to generate cash. The quicker you can generate cash, the more cash you’ll have available to pay suppliers and employees and cover other expenses. Ultimately, as you learn to work with your cash flow statement, you’ll gain more control over your finances and discover more efficient ways to use your financial resources for low-risk growth.
Keep your business essentials in plain view
Done right, a cash flow statement provides valuable insights for different stakeholders. Whether that’s looking into your business’s operations, sources of cash, or how you’re spending it for ongoing operations, cash flow statements cover it all.
Automating the expense management process can help you amplify the impact of cash flow statements, allowing you to better navigate your financial goals and make smarter business decisions.
BILL gives you full visibility into how cash enters and exits the business, so you can spend less time crunching the numbers.
