How to Prepare a Cash Flow Statement

If cash is the lifeblood of a business, then a cash flow statement is something like an EKG. Your business will have inflows and outflows of cash, like lines moving up and down on a chart. There’s a rhythm or a pattern that indicates your company’s good health—or reveals signs of distress. With all the information the cash flow statement reveals, you'll learn if you're good at managing your business' cash, and you'll also know to enhance it. Keep reading to learn how to prepare a cash flow statement.

What is a Cash Flow Statement and Why Do You Need One?

A cash flow statement provides a snapshot of the cash moving in and out of your business over a particular period of time. This document shows you the cash you’re taking in (from sales, investments, etc.) and how much you’re sending out (expenses, payroll, rent, etc.). It gives you a sense of your business's liquidity, in other words, its ability to meet imminent financial obligations.

The cash flow statement provides excellent insight into your business'a health at a particular moment.

But the cash flow statement does more than that. Like an EKG, it can detect future problems as well as current ones. Irregularities might not prove hazardous in the present moment, but they can become destructive in the long run. A blip on your cash flow statement that seems out of sync with previous trends might foretell a pending setback for your business. However, if you arm yourself with extensive information about your cash flow, you will be better positioned to head off potential problems before they arise. That’s why learning how to prepare a cash flow statement is so critical. It enables you to ensure your business has the cash on hand to meet its immediate expenses, and they empower you to prepare for your long-term cash needs. With a full accounting of how much cash you have and where your cash is coming from, you can invest in your business's future without compromising its present operational viability.

#CaminoTip Make sure you understand the difference between cash flow and profit.

Cash Flow Statement Components

Now that you understand the value of the cash flow statement, you need to know its components and how to put together yours. Every inflow and outflow of cash needs to be documented in a cash flow statement, including:

• Operating activities

These include any cash that you acquire or expend operating your business. This includes revenue from sales (so long as you receive cash rather than credit) and expenses like salary, tax, and rent payments.

• Investing activities

Outside of the standard operations of your company, you might take your business’ funds and invest them in real estate, the stock market, or other businesses. While these don’t represent your daily business activities, they are still impacting your cash flow and, therefore, must be represented in your cash flow statement. Any cash you earn and all cash you invest must be accounted for.

• Financing activities

This category represents the cash you receive from outside sources to help support the operation of your business, whether it’s loans or investments, the money you receive from these entities, and the money you pay back in the form of dividends or interest needs to be accounted for.

Methods to Prepare a Cash Flow Statement

There are two ways to prepare your cash flow statement. These 2 different methods are used only in the Operating Activities section of the cash flow statement; the other sections are calculated the same way, regardless of the method.

Cash Flow Statement - Direct Method

The direct method tallies cash taken in and the cash distributed out from the company. It’s the more straightforward method that captures each individual cash-based transaction. In other words, this means that it calculates cash from operations only when cash comes in or out of your business. For a sporting goods store, here’s an example of the operating activities section under the direct method for March:

Cash Flow Statement - Indirect Method

The indirect method uses what is known as “accrual accounting.” So rather than tallying individual activities and transactions, this approach begins with net income and then adjusts it by adding back non-cash accrual activities like depreciation. This means that the indirect method calculates cash from operations whenever cash is earned (not received).  Here’s an example of the March cash flow statement using the indirect method for the same sporting goods store.

Benefits of a Cash Flow Statement

In addition to giving you insight into the health of your business right now and in the future, a cash flow statement has other benefits as well:

• Measures liquidity

To operate effectively, you need cash on hand. Therefore, the cash flow statement measures how effectively you can operate at any given moment.

• Benchmarks your business against its peers

Because cash flow is such a significant measure, other businesses measure it, too. Especially if your business is relatively new and doesn’t have the history of knowing how much cash it needs and when it needs it, it’s a useful exercise to compare where you are relative to businesses similar in size and mission. If you’re in a dramatically different place than comparable successful companies, then that’s a red flag that something needs to change.

• Determine whether you need a business loan

Acquiring a business loan can be a difficult decision, but your cash flow statement can make it easier to decide. Your cash flow statement tells you how much cash you need relative to how much you’re taking in and sending out, and armed with this knowledge; you will know whether you need more cash. If you do, then a business loan might be the right choice.

At Camino Financial, we provide small business loans to cover your working capital needs. In fact, many of our borrowers use our loans as an immediate source of cash flow and funds to cover their operative expenses. Through a quick and easy online application process, you can receive your funds within 4-10 days, so the healthy rhythm of your business doesn’t get interrupted.

Who Uses Your Cash Flow Statement?

 You do, of course. But there are many other stakeholders that need your business’ cash flow statement, as well.

• Accountants

Keeping track of your books means that accountants maintain a close eye on the cash of your business.

In the event of an IRS audit, or simply to ensure that taxes are paid properly, your accountant needs to see and understand where cash is coming from and going to on a highly detailed level. By keeping things organized with a cash flow statement, your accountant doesn’t need to go digging for every scrap of information; he or she doesn’t need to spend hours sifting through receipts and people’s emails.

In short, your cash flow statement helps your accountant be more accurate and timely.

• Lenders/creditors

Before loaning money to businesses, lenders do their homework. They engage with businesses with a track record of bringing in cash and paying their bills (when they’re due).

So the cash flow statement not only helps them ensure they’d be comfortable lending you money, but it also helps you prove your trustworthiness and dependability. Cash is the metric that lenders and creditors want to see. Without having this information available, they’re less likely to go into business with you—even if your cash flow is good.

If you can’t prove your business’s health, it’s not worth their time (or the risk).

• Shareholders

Again, your cash flow statement is your means of proving yourself. It’s your resume, your transcript, your report card. It’s an indicator of your company’s value and a predictor of future earnings.

That’s how you acquire new shareholders and how you convince past shareholders to keep their stake in your business. In the cash flow statement, you also track all dividend payments made to shareholders so they can see how their investment is paying off.

Create a Cash Flow Statement the Easy Way

Monitoring a patient’s heart rate with an EKG allows a doctor to observe any irregularities that might indicate something’s wrong in the present moment or that something might become a problem in the future. Similarly, a cash flow statement provides insight for accountants, business owners, and other stakeholders to assess a company’s at-the-moment status and serves as an indicator of future health (or future problems). With the information provided in a cash flow statement, you can make fully informed decisions to answer key questions about your business. Do you have enough cash on hand to meet your operative expenses? Do you need to take out a business loan to avoid a shortfall in cash flow? If you want to have a cash flow statement without all the hard work required to do all the calculations, the best thing you can do is use a cash flow statement template. Don't worry; we've got you covered with a FREE downloadable. Keep reading:

Cash Flow Statement Template – with FREE Downloadable