The cash flow statement is one of the most important reports a business can run. Like a balance sheet and profit and loss statement, the cash flow statement provides information on the health of your business and is frequently used by investors and financial institutions to assess profitability.
In this short guide we’ll explain what a cash flow statement is and why understanding a cash flow statement is so important for your business.
Overview: What is a cash flow statement?
So what exactly is a cash flow statement? And what is cash flow? In accounting terms, cash flow is the amount of cash that flows into and out of your business.
In turn, the cash flow statement, also known as the statement of cash flows, provides detailed information on all cash related activities that have impacted your business during a specified period of time.
While calculations such as a quick ratio can be helpful in measuring the ability of a business to pay bills, a cash flow statement provides a much more comprehensive picture of your finances.
As cash flows in and out of your business on a daily basis, the cash flow statement is divided into sections that provide detailed information on all cash activities as well as any investing and financing activity, helping to pinpoint cash flow issues and where they may originate.
Sections of a cash flow statement
While knowing the cash flow of your business is important, it’s especially important to know where the cash inflow and outflow originates.
For instance, if cash flow is bogged down by excessive operating expenses, you’ll be able to spot that in your cash flow statement since it’s divided into three sections: operating activities, investing activities, and financing activities.
The cash flow statement below shows cash inflow from operating activities and investing activities such as accounts receivable turnover, while also displaying cash outflow in financing activities.
The operating activities section of the cash flow statement reflects cash use within a business. This can include general day-to-day operating activities such as vendor payments, sales receipts from goods and services, and employee payroll totals.
In the cash flow statement above, operating activities such as customer receipts, interest received, interest paid, and payments to vendors and employees are included in the operating activities section, which displays cash inflow of $214,146.45.
Any change in working capital such as the purchase or sale of any asset such as buildings or land are included in the investing activities section. Transactions like loans, acquisitions, mergers, and cash investments are also included.
Investing activities in the above cash flow statement include proceeds from property sales, as well as payments for property, plant, and equipment. Total cash inflow for investing activities is $656.52.
The financing activities section of the income statement provides information on incoming cash from investors and banks. Dividend payments, the sale of company stock, and the sale or repurchase of company stock are included in this section, as is the repayment on any outstanding principal.
On the balance sheet above, financing activities include proceeds from loans, repayment of a long-term loan, and other cash items from financing activities. Cash outflow from financing activities is ($45,596).
Direct vs. indirect cash flow: What’s the difference?
Even a simple cash flow statement can provide you with valuable information. Of course, the preparation of a cash flow statement will vary depending upon the method you choose, the direct method or the indirect method.
The direct method starts with cash transactions that have impacted your general ledger such as cash spent and received while the indirect method starts with net income and adds back in non-cash expenses.
Whichever method you choose, the end result will be the same, the only difference is the way in which the totals are calculated. When choosing between the direct and indirect cash flow format, only the operating section on your cash flow statement will be affected.
Both the investing and financing sections remain the same. While the direct method provides a much clearer view of incoming and outgoing cash, the indirect method is easier to set up and use.
Direct cash flow
Direct cash flow adds up all of your cash transactions such as vendor payments, cash receipts, and salary expenses, as well as taxes and interest paid. These expenses are then listed in the operating activities section on the cash flow statement.
This can be an issue for businesses that use accrual accounting, which is required in double-entry accounting, as you would need to separate cash sales out from credit sales in order to calculate cash flow properly.
Indirect cash flow
Using the indirect cash flow format requires that you make a series of adjustments including adjusting for interest and taxes paid and received, depreciation and amortization, as well as non-cash income such as gains on property, plants, and equipment.
You’ll also have to adjust for any increases or decreases in current assets and liabilities.
What do cash flow statements tell you about your business?
A cash flow statement gives you a lot of information about the health of your business. In fact, if you’re hoping to attract new investors, much of their decision to come aboard or not will be based on your cash flow statement. But what does your cash flow statement tell you? Here are a few things:
What areas may have cash flow problems
Because it offers a view into cash flow in three vital areas of your business; operations, investing, and financing, the cash flow statement provides you with a good indicator of where your business may be suffering. Is your cash flow poor in investing activities?
Have you seen a decrease in cash in operating activities? The cash flow statement directs you to where the biggest increases or decreases are centered, allowing you to take corrective measures if they’re necessary.
How financially healthy your business is
A business is considered financially healthy if it’s bringing in more cash than it’s spending. There are exceptions to this rule, such as when a business is in a growth phase and cash outflow is increased, but looking at cash flow statements over a period of time provides details on information such as:
- Consistency: Has cash flow remained the same in recent months or does it vary widely?
- Profitability: Is the company consistently profitable or is growth stagnant?
- Decline in profits: Has income declined over the last few months?
How well you’re managing cash
Cash flow provides business owners, as well as potential investors or loan officers, with information on both incoming and outgoing cash, providing details on how that cash is being spent.
Best accounting software to create a cash flow statement
The easiest way to create a cash flow statement is by using accounting software. Here are a few options if you’re looking to automate cash flow statement preparation. You can also check out The Blueprint’s small business accounting software reviews for even more software options.
1. AccountEdge Pro
AccountEdge Pro is designed for small and growing businesses and is available both as an on-premise application and via the cloud. With a feature list that includes accounting, purchases, sales, time billing, inventory, and payroll, AccountEdge Pro can track all financial transactions to create accurate cash flow statements.
AccountEdge Pro uses the indirect method of creating a cash flow statement, using numbers from the profit & loss statement and balance sheet to create the report.
AccountEdge Pro offers one-time pricing with a single-user license running $149, with additional licenses extra. If you wish online access, you can purchase AccountEdge Priority which starts at $50/month.
2. Sage 50cloud Accounting
Sage 50cloud Accounting is a scalable accounting software application designed for small and growing businesses. Available in three plans, Sage 50cloud Accounting offers invoicing and payment capability, along with customer management, automatic bank feeds, purchase orders, and good reporting options.
Sage 50cloud Accounting uses the indirect method for creating a cash flow statement, with an option to create a custom cash flow statement using the direct method.
Sage 50cloud Accounting offers three plans: Pro, at $278.95 annually, Premium, which is $431.95 annually, and Quantum, with pricing available from Sage.
Xero offers online convenience along with an easily navigated interface, all designed with the small business owner in mind. Loaded with features, Xero includes custom invoicing, inventory management, project management, and bill payment features, along with a multi-currency option.
Xero reporting options include the statement of cash flows, which is preformatted using the indirect method. Limited customization options are also available.
Xero offers three plans: Early, Growing, and Established, with the Early plan available for $9/month, while the Growing plan runs $30/month, and the Established plan available for $40/month.
The cash flow statement is vital to your company’s financial health
The cash flow report or cash flows chart is one of the most important financial reports to run, providing you with the details you need to ensure continued financial health for your business.