Cash Flow Statement: What You Need to Know

Updated June 10, 2020

One of the most important things to understand while running a small business is the concept of cash flow. After all, it is critical that businesses have enough money flowing in to keep up with expenses and fund growth. Below, we outline the fundamentals of cash flow statements as well as what you need to understand in order to help your business thrive.

What is a Cash Flow Statement?

A cash flow statement, or statement of cash flows, is a financial statement that summarizes cash inflows and outflows from operating, investing, and financing business activities over a specific time period. 

By showing how changes in balance sheet accounts and income affect your cash and cash equivalents, the statement measures how well your company manages its cash position, how much liquidity is available, and how money is being spent. 

Cash flow statements complement the balance sheet and income statement and are a mandatory component of a company’s financial reports. By having a firm understanding of your cash inflows and outflows, you will be better equipped to make financial decisions for your company and improve operational efficiency for all of your business activities. 

Positive Cash Flow vs Negative Cash Flow

Positive cash flow occurs when a company takes in more money than it pays in expenses. On the contrary, negative cash flow occurs when a company pays out more money than it receives as revenue. In general, positive cash flow is always the goal, as it signifies that a company is making a higher profit and should have working capital on hand to support daily operations. 

With that said, negative cash flow isn’t always a bad thing. For example, a company may invest heavily in new machinery or technology to drive growth, resulting in negative cash flow for one month. This doesn’t mean that the company is unsuccessful, but rather they used a significant amount of cash to position the company for future success. Experiencing temporary negative cash flow is not uncommon, but continuous negative cash flow is a serious problem as at some point you may not have enough liquidity to maintain business continuity.

How Do Cash Flow Statements Work?

In general, there are three types of cash flow statements: operations, investment, and financing. Each type of cash flow statement targets specific ways that cash is moved in and out of a business to analyze a company’s decision making as it relates to operational efficiency, investments, and financing strategy. 

Cash flow statements are utilized by cash accounting and are calculated by making adjustments to net income by adding or subtracting differences in revenue, expenses, and credit transactions resulting from transactions that appear from one period to another. Because not all transactions involve cash items, many items may need to be re-evaluated when calculating cash flow, which is why there are two methods for calculating cash flow.

Cash Flow Statement Indirect Method vs. Direct Method

Cash flow statements can be calculated using either the direct method or the indirect method. The direct method calculates the beginning and ending balances by adding up all of the various cash transactions, such as cash paid to suppliers, cash paid in salaries, and cash receipts from customers. The direct method ignores all non-cash factors such as depreciation. While adding everything up may take more time, the direct method is generally a more accurate measure of cash flows.

The indirect method uses the net income as a base and then adds non-cash expenses such as depreciation and accrued expenses before deducting non-cash income, such as adjustments between assets and liabilities. The indirect method is generally less accurate than the direct method because a company’s income statement is prepared on an accrual basis, meaning that revenue is only recognized when it is earned rather than when it is received.

The Classifications of Cash Flow

The three main areas of cash flow are operating activities, investing activities, and financing activities. Operating activities cover any cash flow related to the day-to-day sales of business (or net income). Investing activities include any cash flow related to a company’s noncurrent assets, such as long-term investments, property, plant, equipment, and the principal amount of loans made to other entities. Financing activities include cash activities related to noncurrent liabilities and owners’ equity, which includes the principal amount of long-term debt, stock sales and repurchases, and dividend payments. Keep in mind that interest received from loans or paid on long-term debt is included in operating activities.

Cash Flow from Operating Activities

Cash flow from operating activities includes any and all cash used to support business activities. Common examples of cash flow used for operating activities include:

• Receipts from sales
• Payments made to suppliers and vendors
• Salary and wage payments
• Rent payments
• Income tax payments
• Interest payments
• Other operating expenses

Cash Flow from Investing Activities

Cash flow from investing activities includes any cash that is involved in a company’s investments. This may include the following:

• Purchase or sale of an asset
• Loans made to vendors or received from customers
• Equipment purchases
• Purchase of a building or storage space
• Payment related to a merger
• Other investments for the company

Cash Flow from Financing Activities

Cash flow from financing activities includes any cash related to noncurrent assets or owner’s equity and includes the following:

• Cash from investors or banks
• Cash paid to shareholders
• Payment of dividends
• Payment for stock repurchases
• Repayment of small business loans
• Other financing activities

Cash Flow Statement Example

Below is an example cash flow statement to help you better understand the components that go into each category of activities. Keep in mind that different industries and businesses will have different sources of cash inflows and expenses.

Cash Flow from Operating Activities
Net Income	+$1,000,000
Depreciation	+$5,000
Increase in Accounts Payable	+$10,000
Decrease in Accounts Receivable	+$10,000
Increase in Taxes Payable	+$1,000
Increase in Inventory	-$100,000
Net Cash from Operating Activities	+$926,000
Cash Flow from Investing Activities
Equipment	-$300,000
Purchase of Storage Space	-$100,000
Cash Flow from Financing Activities
Payment to Shareholders	-$20,000
TOTAL CASH FLOW	+$506,000

Because of the vast difference in cash inflows and outflows across industries and business models, as well as the temporal aspect. cash flow statements must be taken with context. After all, different businesses have different profit margins and supply chains. Additionally, a growth-minded company may make a heavy investment one month or year and show negative cash flows. At first glance, their financial statements may be a concern when in reality the company is likely thriving. 

That said, if you analyze your cash flow statements with a full understanding of how the analysis should be applied to your business, you can effectively improve operational efficiency as well as your cash position.

 

Author Bio:

Jeffrey Bumbales

Director, Marketing & Strategic Partnerships