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I am not a big fan of pumpkins or espresso. But smash pumpkin "spice" (which is really a bunch of non-pumpkin related spices) and espresso together to make a pumpkin spice latte, and I will eagerly waste 150 calories or so on it every day.
The statement of cash flows is similar. The balance sheet and income statement, traditional financial statements, only tell you part of the story. The income statement is full of arcane line items calculated on an accrual basis, and the balance sheet can be boiled down to a simple chart of accounts with no explanation of what caused the change in each account.
In this article, we’ll go over how to create your cash flow statement by smashing together the income statement and balance sheet.
The income statement uses the direct method to calculate net income. You start with revenue and subtract out all expenses to discover what is left.
The cash flow statement is calculated with the indirect method: we start with net income and reconcile our way to cash flow.
The cash flow statement is broken down into three sections: operating, investing, and financing. Let’s peruse the financials of Target Corporation (TGT) to do a cash flow analysis.
Operating
Operating activities are all transactions affecting cash related to operations. Let’s go through the line items that would likely apply to your business:
Investing
Investing activities are all uses of cash for long-term assets. For your business, this would likely include purchase of capital equipment, company vehicles, and the down payment for a new building.
Target spent just over $1.4 billion on property and equipment and earned $10 million in cash from selling or disposing equipment and property. Any other cash flow from assets, such as investment income, would appear in this section.
One of the most common methods of cash flow, free cash flow, appears in the operating and investing activities section. The formula is:
Operating Cash Flow - Capital Expenditures = Free Cash Flow
Capital expenditures are the cash outflows for property and equipment. You can get a better reflection of the actual cash earned and spent by the business using operating cash flow and capital expenditures.
Using the indirect method, calculate capital expenditures by subtracting last period’s fixed assets total from this period’s.
Financing
In a young and growing business, we use the operating section to see if the business broke even, the investing section to see how the business is investing in long-term assets for its future, and the financing section to see where all the money came from.
The financing section shows how cash was added to the company with new debt or capital investments and how it was spent to pay down debt or reward owners with dividends.
At the end of the graphic there is a final reconciliation of the cash account. Beginning cash is what the balance was on the balance sheet last period and we have indirectly shown how to get to the cash balance for this period.
The income statement and balance sheet have their own purposes, but the cash flow statement will give you the full picture on how cash, the most important account, is flowing through your business.
It’s likely your accounting software can run cash flow reports. However, taking the time to produce the report on your own could help pinpoint problems, such as inventory that is growing faster than revenue or debt that could be paid down faster.
The most common cash flow statement is the Uniform Credit Analysis (UCA) cash flow statement. This format is widely used by lenders and is structured in a way to get a better idea of whether cash from the business can service debt payments.
Even as an accountant, I recognize many of the traditional account reports can seem superfluous. The cash flow statement is not. The popular saying that cash is king is popular for a reason, and there’s no better report to learn about how you are using and conserving cash.
Our Small Business Expert
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