A cash flow statement is a financial statement that summarizes the cash flowing in and out of a company during a specified time period. It is an important measure of how a company generates and manages its cash because it shows how much cash is available to fund operations and pay debt.
The cash flow statement, together with the income statement and balance sheet, is one of the key financial statements used to measure a company's position. It presents a comprehensive picture of a company's strength and profitability, providing critical information for investors, creditors, and management.
Why do you need a cash flow statement?
A cash flow statement is necessary because there are several non-cash transactions that a business can potentially engage in. This is especially true for businesses that use accrual accounting since they may be tracking non-cash accounts like accounts receivable, accounts payable, and inventory. A cash flow is still helpful for cash-basis accounting because it will also reflect any loans received as well as assets purchased or sold.
This type of accounting gives a picture of a business's finances based on when activities are completed versus when cash outlays are made.A company with a profitable income statement but insufficient cash flows is not likely to be a profitable investment, as it will not have the necessary cash to continue operations.
Comparing changes in cash flow from one period to the next shedsan important light on the direction the company is headed in.
Creating a cash flow statement
To create a cash flow statement, organize all cash transactions under the following three primary sections.
- Cash from operating activities. Record cash expended and received from the company's main line of business. Typically, this is the most telling category, since it shows whether the company's core business is generating enough cash for sustainability.
- Cash from investing activities. Record cash changes in assets or equipment, or general monetary investments.
- Cash from financing. Record cash changes related to investors, loans, or dividend payments made.
Additionally, you may need to use notes or an attachment to disclose certain non-cash activities which are part of a full snapshot of the company's position, such as acquiring an asset by assuming a liability.
Direct and indirect methods
The direct or indirect method may be utilized to prepare the cash flow statement. Under either method, the investing activities and financing sections are identical. The difference between the two methods impacts the operating activities section only.
For the direct method, simply list all cash payments and receipts from operations, such as receipts from the sale of goods or services, payments to suppliers, salary, rent, and other operating expenses.
For the more commonly used indirect method, begin with net income as a starting point and make the necessary balance sheet adjustments to arrive at an accurate cash flow figure. The following are some of the most common adjustments to net income when calculating cash flow:
- Depreciation. A non-cash expense on the income statement, depreciation is added back to net income for cash flow purposes.
- Accounts receivable. Increases in accounts receivable are deducted from net income, as no cash has been received for these sales. Conversely, decreases to accounts receivable are added back to net income, because they represent cash received.
- Payables. Increases in payables are a non-cash accrual and are added back to net income.
- Inventory. If purchased with cash, an increase in inventory would mean a cash outlay that reduces net income.
Below is an example of a cash flow statement prepared using the indirect method. Although earnings are $250,000, not all of that amount is available for use, as the bottom line shows.
Cash flow statement
Company ABC
Month ended Jan. 31, 2021
Cash flow from operations
Net earnings
$250,000
Additions to cash
Depreciation
$7,500
Increase in accounts payable
$24,000
Increase in Taxes Payable
$8,000
Subtractions from cash
Increase in accounts receivable
($35,000)
Increase in inventory
($40,000)
Net cash from operations
$214,500
Cash flow from investing activities
Purchase of equipment
($12,000)
Net cash from operations
($12,000)
Cash flow from financing activities
Notes payable
$16,000
Dividends Paid
($900)
Net cash from operations
$15,100
Cash flow for month ended Jan. 31, 2021
$217,600
A properly created cash flow statement is an important bridge between the income statement and balance sheet and provides critical information for all decision-makers. You should also consider consulting an accountant or bookkeeper when creating financial statements.
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