How to Build a Cash Flow Statement

If you are putting together a business plan for a loan or investment, your cash flow statement is one statement that your plan needs. Investors want to see how much cash is moving into and out of your business. Your cash flow statement helps you understand how much cash you need to raise and by when you need it.

Cash flow statements are not just for investors but is crucial to have for running your business. It is the best way to get ahead of any issues in cash flow before they threaten your long-term viability. Review your cash flow statement regularly to see when in the future you might be at risk of running low on money so you can plan ahead and get a loan, line of credit, or another type of financing.

What is a Cash Flow Statement?

Cash flow statements show the inflows and outflows of the cash. It shows how much cash a business has on hand and how that number changes over time. A typical cash flow statement shows cash flow on a monthly basis over a 12-month period.

Cash flow statements are essential for the following reasons:

  • They show your liquidity so you know what you can afford and what you cannot afford.
  • They show you changes in assets, liabilities, and equity in the forms of cash outflows , inflows, and cash being held.
  • They let your predict future cash flows so you can plan for how much liquidity your business will have in the future.

The Components of a Cash Flow Statement

There are three main components of a cash flow statement.

Operating Activities: your organization’s operating activities include everything that relates to how you generate revenue. Cash inflows are generated whenever customers buy your products or services; outflows occur when you pay employees, suppliers, taxes, or interest.

Investing Activities: these activities include transactions related to the sale or purchase of property, equipment, or other non-current assets included in your investing activities, as are any expenses tied up in mergers or acquisitions.

You also need to indicate when you buy or sell securities if your business plays in the stock market at all.

Financing Activities: this section of the cash flow statement has information about taking out loans to buy property or equipment, issuing stock to employees, the public, or other stakeholders. Cash flow statements can be affected by non-cash transactions like depreciation or bad-debt expenses. Many businesses choose to add information about large transactions that do not involve cash, like converting debt to equity or issuing share in return for assets.

Cash flow statements can be prepared using the direct method or the indirect method, both produce the same results. Most businesses build their statements of cash flow via the indirect method.

Indirect Method of Building a Cash Flow Statement

Many businesses choose to construct their cash flow statements using the indirect method because the numbers are easily gathered from their accounting software. Cash flow statements generated this way reconcile reported net income with cash generated through operations. The indirect method works if you are building a cash flow forecast to predict how much cash you will have on hand in the future.

You first need to focus on operating activities to construct your indirect cash flow statement. Determine your net income and remove non-cash expenses from that number. You will find your net income on your income statement (also called profit and loss statement).

After that you need to consider your gains and losses on any sales of assets made. You also need to report any changes in accounts receivable, accounts payable and inventory, as well as any bad debts you might write off.

When you have figured your net cash provided by operations, you need to record your cash flows from investing and financing activities. These sections are reported in the same manner on cash flow statements prepared using both the indirect and direct methods.

Direct Method of Building a Cash Flow Statement

Cash flow statements using the direct method provides a clear view on how much cash moves through a business. However, they are harder to prepare which is why they are less common.

Cash flow statements made through the direct method focus on gross cash inflows and gross cash outflows that occur naturally through operations.

Businesses that use the direct method need to consider cash received from client accounts, cash paid to employees and suppliers; interest payments; income tax payments; and any interest that was received. Unlike the indirect method, when cash flow statements are generated through the direct method it is easy to see where cash payments were made and where cash payments were received.

The Bottom Line

Because most account reports do not include the necessary information the direct method requires, many businesses chose to take the easier route and produce their statements of cash flow using the indirect method. However, the direct method works great as well and will get you the same results. Cash flow statements are powerful tools, so long as they are used in tandem with income statements and balance sheets.