Steps on How to Prepare a Cash Flow Statement
A cash flow statement is one of the most important financial reports for any business. It shows how money moves in and out of your company over a specific period, helping you track liquidity and understand your business’s financial health.
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Understanding Cash Flow Statements
The cash flow statement summarizes all cash inflows and outflows from operating, investing, and financing activities. Unlike the income statement, which includes non-cash items, this statement focuses only on actual cash movements, making it essential for evaluating a company’s ability to generate cash and meet obligations.
Components of a Cash Flow Statement
- Operating Activities: These are the day-to-day business activities that generate revenue and expenses. Examples include cash received from customers and cash paid for inventory, salaries, rent, or taxes.
- Investing Activities: This section records cash used for or generated by investments in assets. Examples include purchasing equipment, selling property, or receiving returns from investments.
- Financing Activities: Here you capture cash from borrowing, repaying debt, issuing shares, or paying dividends. It reflects how a company funds its operations and growth.
Steps to Prepare a Cash Flow Statement
- Collect Financial Data: Gather the balance sheet, income statement, and other relevant records for the period.
- Calculate Cash from Operating Activities:
- Indirect method: Start with net income and adjust for non-cash expenses (like depreciation) and changes in working capital .
- Direct method: List cash received from customers and subtract cash paid for expenses.
- Determine Cash from Investing Activities: Record cash spent on purchasing fixed assets or received from selling investments.
- Calculate Cash from Financing Activities: Include loans raised or repaid, issuance or buyback of shares, and dividends paid.
- Combine All Sections: Add operating, investing, and financing totals to find the net increase or decrease in cash for the period.
- Reconcile with Opening and Closing Balances: Ensure the closing cash balance equals the ending cash on the balance sheet .
Direct and Indirect Method
When preparing the operating activities section, you can use either:
- Direct Method: Lists all major cash receipts and payments, such as customer payments and supplier payments.
- Indirect Method: Starts with net income and adjusts for non-cash items and changes in working capital.
Differences Between Direct and Indirect Methods
| Feature | Direct Method | Indirect Method |
|---|---|---|
| Starting Point | Actual cash receipts and payments | Net income from the income statement |
| Adjustments | Minimal adjustments | Adjusts for depreciation, accruals, etc. |
| Popularity | Less common due to detailed data requirement | Most common because it uses existing records |
Analyzing a Cash Flow Statement
- Positive operating cash flow signals healthy core operations.
- Negative investing cash flow can mean growth if it comes from asset purchases.
- Positive financing cash flow may show new loans or share issues, while negative indicates debt repayments or dividend payouts.
Common Indicators and Red Flags
- Consistently negative operating cash flow may indicate trouble even if profits look good.
- Large financing inflows can mask weak operating performance.
- Significant unexplained fluctuations may suggest accounting issues.
Cash Flow Statement
| Particulars | Amount |
|---|---|
| Operating Activities | |
| Net Income | 150 |
| Add: Depreciation | 20 |
| Less: Increase in Accounts Receivable | (30) |
| Less: Increase in Inventory | (10) |
| Net Cash from Operating Activities | 130 |
| Investing Activities | |
| Purchase of Equipment | (50) |
| Net Cash from Investing Activities | (50) |
| Financing Activities | |
| Loan Received | 40 |
| Dividend Paid | (20) |
| Net Cash from Financing Activities | 20 |
| Net Increase in Cash | 100 |
| Opening Cash Balance | 50 |
| Closing Cash Balance | 150 |
What is the Statement of Cash Flows?
It is a financial report that provides details of cash inflows and outflows during a period, helping stakeholders understand how a business generates and uses cash.
Why is the Cash Flow Statement Important?
- Shows liquidity and ability to pay bills
- Helps assess operating efficiency
- Guides investment and financing decisions
- Provides insights beyond net profit figures
Cash Flow Definitions
- Cash Inflows: Actual cash received, such as sales collections, loan proceeds, or asset sales.
- Cash Outflows: Actual cash paid, such as supplier payments, salaries, or asset purchases.
Cash Flow Statement Sections
- Operating Activities – core business operations
- Investing Activities – buying or selling long-term assets or investments
- Financing Activities – debt, equity, and dividends
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Conclusion
A cash flow statement tracks the actual movement of money, revealing a company’s ability to generate cash and maintain liquidity. By understanding its components—operating, investing, and financing activities—and following a step-by-step preparation process, businesses can maintain accurate records, plan for growth, and spot financial red flags early. Whether using the direct or indirect method, the goal is the same: present a clear picture of where cash is coming from and where it is going.
