Understanding Business Statement of Cash Flows

In this article:

• What is a Statement of Cash Flow?
• What’s on the Statement of Cash Flows?
• What the Statement of Cash Flows tells users about the business
• Preparing a Statement of Cash Flows
• Tips to increase cash flow

What is a Statement of Cash Flow?

A business statement of cash flow, or cash flow statement, is a standard financial statement generated by nonprofit organizations and for-profit businesses that shows available funds, or free cash flow. In order for a small business to succeed, the business owner must have a thorough understanding of how each financial transaction, like collecting revenues and making debt payments, affects the overall financial position and net cash flows of the company. Understanding financial statements is an efficient way for entrepreneurs to quickly assess the business’s performance and make informed business decisions going forward.  There are many financial reports used in business, but the three most common financial statements are:

• Balance Sheet – The balance sheet quickly shows users how much a business is worth at a certain date by listing the assets (what the business owns), liabilities (what the business owes), and the owner’s equity in the company.
• Income Statement – Also called a profit and loss (P&L) statement, the income statement shows a business’s revenues (money coming in), expenses (money going out), and profit (amount of money left over once all obligations are met). Income statements can be generated for a given period of time and are typically created to show one month or one full year of activity.
• Statement of Cash Flows – The cash flow statement shows changes (inflows and outflows) in cash and cash equivalents over time. Financial transactions on the cash flow statement are broken down into one of three categories: operating, investing, and financing activities.

While each financial report can be used alone, a company’s financial health is more commonly assessed by looking at multiple types of statements. The statement of cash flows is not any more important than the income statement or balance sheet, but it is important for new business owners and seasoned entrepreneurs to learn how to interpret this report and use the provided information to meet the business’s goals.

Ways to prepare a cash flow statement

There are two methods that can be used to prepare a business statement of cash flows. Both methods are recognized by the standardized accounting industry guidelines, or Generally Accepted Accounting Principles (GAAP).

• Direct method – Shows cash activity by listing the money coming into and out of the business. Cash flow is calculated by subtracting outflows from inflows. Requires accounting software or manual internal processes to track cash receipts and payments.
• Indirect method – Shows cash outflows as they relate to profit, providing users with a reconciliation of cash flow to net income. This method also factors in depreciation for fixed assets and capital expenditures, like buildings and equipment, into the presented cash flow.

What’s on the Statement of Cash Flows?

As previously mentioned, the cash flow statement categorizes transactions into three categories. Separating cash into these categories helps business owners see where income is coming from and being used as well as identify areas where the business can improve or increase cash flow.

Cash from operating activities

The movement of money because of operating activities appears first on a statement of cash flows. The cash from operating activities section describes money that is made or spent during ordinary operations, like providing goods and services and paying monthly operating expenses as described in the initial business plan. Any changes in savings or checking account balances, current assets, depreciation, inventory, and accounts payable totals can impact cash from operating activities.

Cash flow from operating activities is broken down into inflows and outflows in order of liquidity in this section of the cash flow statement as follows:

Cash from operating activities – cash inflows

• Sales revenues
• Money collected in exchange for services provided
• Commissions and royalties

Cash from operating activities – cash outflows

• Monthly rent for office space, studio area, retail store, or restaurant space
• Utility expenses
• Sales taxes, income taxes, and payroll taxes
• Payments to vendors and suppliers
• Employee salaries and wages
• Interest payments
• Operating expenses, as included in accrual accounting

Cash flow from investing activities

The section of the statement of cash flows dedicated to investing activities is listed after operating activities and shows the movement of money that results from changes in the business assets. Since the cash flow statement helps entrepreneurs analyze cash flow from assets, much attention is given to the investing activity section. Examples of the changes in cash that is categorized as cash flows from investments include:

• Buying and selling assets, like equipment, buildings, and securities
• Loans and credit lines to or from vendors and customers
• Merger and acquisition (M&A) activities
• Dividends and interest received from investments

Cash from financing activities

Even though it can be hard to understand the difference between investment activity transactions and financing activities, it’s important to remember that the cash inflows and outflows categorized as financing activities come from capital finance providers, like investors, banks, and shareholders. Examples of cash flows from financing activities include the following:

Cash flow from financing activities – cash inflows

• Money received from borrowing from a financial institution, like traditional banks and credit unions
• Proceeds from issuing shares and debentures (long-term debt issued by a government or corporate organizations)

Cash flow from financing activities – cash outflows

• Loan repayments (principal payments on debt borrowed from a financial institution)
• Buying back shares and debentures
• Dividends paid out to shareholders

What the Statement of Cash Flows tells users about the business

Some users confuse cash flow with profit, but they are different metrics when used in business. While profit shows how much of a company’s earnings are left over after expenses have been covered, cash flow shows how much cash is available as of a certain date. In a nutshell, the statement of cash flows highlights the entire path of money as it enters and exits the organization. It gives managers, business owners, and third-party evaluators insight into where and how earned and contributed revenues are being spent. Having access to a snapshot view of how cash outflows and cash inflows are impacting available funds gives decision-makers the tools they need to make decisions about expansion, growth, inventory purchases, budgeting, investments, marketing, hiring, and even closing the business.

In addition to being a valuable tool for business owners, there are many external users that may request a copy of your business’s statement of cash flow. Those users may include:

• Creditors – when evaluating a company’s ability to pay current and future debts the statement of cash flows should show enough cash to take on the new obligation
• Lenders – banks and online lenders may request a cash flow statement during the loan application process for business financing options, like a term loan or business line of credit
• Investors – businesses that receive contributions from investors, either in exchange for a percentage of equity or another repayment arrangement, may request a statement of cash flows
• Shareholders – public companies that sell shares through the stock market must be prepared to provide a statement of cash flows as well as show the company’s net income

Reading the statement of cash flows

Each category on the cash flow statement lists the net result of cash inflows and outflows as line items for a specific period. When interpreting cash position, it’s important to understand if you are looking at one month of activity or longer, like one, two, or three years. The information given on this financial report shows the change in cash data at the end of the given period.  Typically, the ending balances reported on the statement of cash flows is compared to the balance at the beginning of the fiscal year. For example, the accounts payable amount listed on the cash flow statement and June 30, 2023 shows the change in that balance from January 1, 2023.

Net cash flows for each of the three types of activities are represented on the statement as either a positive or negative number. A positive balance indicates that the amount of that actual cash, cash equivalent, or asset has increased, while a negative cash flow balance indicates a decrease in value. Overall, positive cash flows mean that the operating, financing, or investing activity generated cash for the company. Negative balances indicate that the activity cost the business more money than it made. However, a negative net cash flow balance is not necessarily an indicator of poor performance. For example, making scheduled loan payments may result in negative balances in the financing activities section. However, using cash generated by the business to decrease debt will benefit the business long-term and is considered a good use of cash.

Preparing a Statement of Cash Flows

There are several ways to prepare a statement of cash flows. The exact process or procedure a small business owner uses to generate financial reports depends on several factors, including personal preference, software capabilities, number of staff members, and the annual revenues of the business. Some business owners choose to outsource accounting functions to an accounting or bookkeeping firm where they feed the firm transactional data and the firm provides completed financial statements each month. However, most small businesses prepare financial reports, including the cash flow statement in-house. They may use an accounting software, like QuickBooks or Sage Intacct, that will generate the report from parameters provided or create the statement manually using a pencil and paper or application like Microsoft Excel.

No matter the method a company uses to prepare a statement of cash flows, the steps taken follow the same basic principles:

1. Start with the cash balances from the bank account on the first day of the fiscal year or accounting period
2. Add the amount of annual, or periodic, money that came in from operating, investing, and financing activities
3. Subtract the amount of cash used in operating, investing, and financing activities
4. The net cash flow result on the statement should tie out to the ending balance in the bank

Tips to increase cash flow

One of the most useful aspects of a statement of cash flows is that it shows users where money is coming from and going, so it can easily be used as a guideline to making improvements on the business’s performance. If you are interested in increasing the cash flow at your business, check out the following tips for improving cash position.

• Increase revenue – Increasing the amount of money your business is bringing in is the most direct way to improve cash flow. Revenue can be increased by attracting new customers with strategic marketing campaigns or raising prices on the current products and services provided.
• Collect on receivables – A company’s accounts receivable (AR) balance negatively impacts net cash flow because while AR is considered a current asset on the balance sheet, it does not increase cash from operating activities until unpaid invoices are collected.
• Cut costs – Improve cash flows by reducing the costs of goods production or supplies through negotiating better prices with manufacturers and suppliers or by decreasing the amount of supplies on hand. Cash flow will also improve if you can cut back on ordinary business operations, like labor costs and office rent.
• Consider good debt – Making payments on debt, like small business loans, decreases cash flow but is not always a bad thing. Healthy debt is still a great way for businesses to get affordable access to the capital they need for startup costs, large purchases, or working capital. When borrowers receive lump sum payments upfront, it causes a short-term increase in cash flow, so it is important to also understand the impact payments will have.

Bottom Line

Understanding your company’s cash flow is the first step in achieving and maintaining a healthy financial position. The statement of cash flows is used by business owners to quickly assess how much cash is on hand and how each operating, investing, and financing activity impacts the flow of funds. To improve your business’s cash flows, focus on increasing revenues, cutting costs, and obtaining healthy debt, like Website Depot did when they were approved for a term loan through Biz2Credit.