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Cash Flow Statement: How to Prepare and Analyze

Irina Tsymbaliuk

Financial reports and statements are essential to any company, as they help understand the current standing of a business and thus make informed decisions about its future. The size of the company doesn’t matter in this context, as even small ones need to be keenly aware of their financial situation. If you want to be mindful of the economic processes that define your business, one of the most important tools you can use is a cash flow statement. 

By drawing up this statement, you gain valuable insight into spending activities, get a better chance of increasing your financial effectiveness, and make timely data-driven adjustments. 

In this article, you can learn how to prepare a statement of cash flows and the right way to analyze it once it is finished. 

Prepare a Statement of Cash Flow in a Few Steps 

Before discussing the methods of drawing up a report, let’s focus on the cash flow statement definition. It is a type of financial statement that describes in detail how a business spends its money. Once it is finished, you are supposed to see the movement of cash equivalents and budget in your company.

The cash flow statement format is designed to show the inflow and outflow of finances from three different components: 

Operating activities

This category includes any inflow or outflow of cash related to a company’s business activities. The examples include receipts for provided services and sold goods, production costs, rent payments, and salaries to employees. If we are talking about an investment company, operating activities also include receipts from the sale of equity instruments, loans, etc. 

Financing activities

Money from stock sales, shareholder dividends, banks, and investors. For example, a company experiences an outflow when interest is paid to shareholders. On the other hand, when a company issues a share, it receives an inflow. 

Investing activities

Just as the name suggests, this category refers to money obtained from a company’s investments. Finances from investing activities include loans received from customers, sales/purchases of assets, and more. It is important to note that this category only includes investing activities that involve the use of free cash rather than debt.

The general format of a cash flow statement is based on the analysis of all three mentioned categories of activities. The two main approaches to drawing it up are the direct and indirect methods.

Direct method 

The direct method of obtaining a cash flow statement involves subtracting the sum of expenditures from the total inflow of money from operating activities, thus getting a net income.

This approach includes all the company’s transactions in the statement, which makes it better suited for smaller businesses. Keep in mind that with this method, investing and financial activities are included once the cash flow from operating activities is calculated. 

Indirect method 

Another method that companies can use is the indirect method of cash flow calculation. The way it works is that a company starts drawing up the statement with net income and then either deducts or adds differences from non-cash transactions and expenses. Usually, this refers to changes in assets, liabilities, and non-operating losses.

Analyzing Cash Flow Statement: Benefits and Methods 

Once you are familiar with the statement of cash flow examples, you may want to create one for your company. However, it is useful only if you know how to read it. The benefits of a well-done analysis include:

  • A clear evaluation of the company's overall performance.  
  • An in-depth understanding of the company’s spending. 
  • A possibility to achieve a healthy economical balance. 
  • Improved short-term financial planning. 

What company wouldn’t want to receive these benefits just by just creating a cash flow statement? But you should also understand what methods you can use to define the liquidity of your business better. There are two tools most widely used for this:

  • Cash flow margin ratio. To get this ratio for your company, you need to take your cash flow from operations and divide it by sales. As a result, you will get a better picture regarding financial flow in your business compared to simply calculating the net profit. 
  • Cash flow coverage ratio. This ratio is calculated by taking operating cash flow and dividing it by total debt. A sufficiently high number in this case indicates that your business has enough cash flow to pay for its debts and interest payments. 

These are just some of the coefficients that you can use to analyze your cash flow statement, but they still give you an idea of your financial situation beyond calculating net profit. 

One thing that many people wonder about is how a cash flow statement differs from a balance sheet and income statement. The income statement is the most common report type, and it is created to show total expenses and revenue, including non-cash accounting. A balance sheet, on the other hand,  also includes non-cash items in its calculations. But a cash flow statement doesn’t include this information and focuses entirely on money movements.

It is always a great idea to use a combination of these three financial statements in your company to get the best level of financial understanding. 

Final Thought 

Preparing a cash flow statement is essential for determining your company's financial situation and ways to improve it. With such a report, you won’t lose track of spending and will be able to maintain a better money balance. One thing to note is that a cash flow statement has its limitations, as for example a negative one does not always mean that something is going wrong. Sometimes, poor cash flow is temporary, like if the company is currently expanding.

If you have a small business, it is advisable to use a direct method of drawing up a statement, as it is the most straightforward option. Also, if you have never created this type of financial statement before, it is a good idea to look up a sample cash flow statement online. 

FAQ

What is the difference between direct and indirect methods of drawing up a cash flow statement? 

The direct method involves taking money inflow from operating activities and deducting cash disbursements from other types of operating activities to reach net income. The indirect cash flow statement method begins with the net income. Then, financial specialists add or deduct non-cash revenue and expenses from the obtained sum.

How is the cash flow statement different from the income statement and balance sheet? 

When you look at any cash flow statement example, it is obvious that this paper is focused solely on financial transactions to see how a company is dealing with cash. Balance sheets and income statements, on the other hand, use both non-cash and cash items in the calculation process.

What are the examples of cash inflows and outflows from investment and financial activities?

Cash inflow from monetary activities includes issuance of shares and bonds as well as availing of loans from financial institutions. Cash outflow refers to dividend payment, repayment of debt, and buyback of shares. 

As for investment activities, cash inflow includes receipts from dividends and interest obtained as returns on loans. Cash outflow includes the purchase of any investment.