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Cash Flow Statement: Definition, Calculation, and Examples

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By Phil Cohen

The strength of a business often rests in three primary places: the employees, the processes, and the finances. When it comes to finances, failing to maintain an accurate profit and loss statement can cause serious problems. You have to be able to look at a specific period and be able to measure the business’s profitability. 

It’s just as important to manage the cash flow statement properly and have a document that you can rely on. Even if you’re looking at paying employees in cash, you must have your documents in order. 

Here’s what you need to know about the cash flow statement. 

What Is a Cash Flow Statement?

A cash flow statement is a top-level view of the money entering the business, as well as the money leaving the company. It can be viewed as cash into the business and cash out of the business. Knowing your business’s cash flow is just as important as the profit and loss statement

How you build a cash flow statement depends on whether your business uses cash or accrual accounting.  

With cash, you are accounting for things as you receive them directly, and with accrual, you are accounting for items as soon as they appear, even if payment is at a later date. 

The Structure of a Cash Flow Statement

Typically, a cash flow statement has three major components, and they all showcase a different aspect of the business, from operating activities, investing activities, and financing activities. Here’s what you need to know about these three main components: 

  • Operating activities: This is cash related to operational costs, such as interest payments, vendor payments, and sales receipts.
  • Investing activities: Cash related to the movement of equipment, assets, or investments.
  • Financing activities: This would be all cash related to the movement of money between investors, shareholders, dividends, and payment of debt principal (loans). 

Investors will use this information to examine your business’s potential for the future as part of their due diligence. 

Why Do You Need Cash Flow Statements?

Cash flow statements are necessary because you must be able to examine how well your business handles its responsibilities in terms of debt as well as bringing in revenue. Everything is connected, from liquidity, all the way up to accurate cash flow projections. 

Have you ever started a new business and wondered how well the business will do a quarter from now or even a year from now? Cash flow projections help give an idea of how well the business can grow. 

How To Use a Cash Flow Statement

Executives and investors can use a cash flow statement to analyze how much cash is coming into the business, how much is going out, and determine the company’s financial standing. A well-constructed cash flow statement illustrates how much money the business is paying into operating expenses, like payroll; how much money the business is investing in assets, like equipment and services; and whether the business is slowing or growing.

With this information on hand, the company can decide which monies are being spent efficiently and which aren’t. For instance, if a business sees from its cash flow statement that its investments in intermodal shipping services are slicing profit margins, it may decide to relocate inventory closer to customers and utilize a more affordable shipping solution.

A creditor can also review your cash flow statement to see how well the business is going and whether to extend credit terms. For a business without a credit score, these fundamentals come into play. Some are willing to look at financial statements instead of a set credit score.

Negative Cash Flow vs. Positive Cash Flow

Just as with the profit and loss statement, it’s possible to have a negative cash flow as well as a positive cash flow. It just depends on the numbers. In terms of a negative cash flow, it means that more money is leaving the business than what is coming into the business. 

Positive cash flow means that the money coming into the business is greater than the money leaving the business. However, a positive cash flow in a set period can still spell trouble for a business, especially if there are issues in the revenue pipeline. More information is needed, which is why all statements require careful examination as a set.

A business with consistently negative cash flow should consider ways to improve cash flow, such as invoice factoring to cover urgent expenses. With invoice factoring, you use incoming invoices as collateral to get the necessary funds upfront. 

Many industries turn to factoring services periodically, especially when unexpected changes in demand drive fluctuations in staffing and associated operating expenses. Industries facing a labor shortage may also require factoring to stabilize staffing while pay is adjusted. For instance, medical staffing factoring became urgent in the wake of the COVID-19 pandemic driving a surge of patients to healthcare facilities.

How Cash Flow Is Calculated

Just as there are two systems of accounting, there are also two different methods of calculating cash flow. The first method is direct cash flow, and the other method is indirect cash flow. The direct method is more in-depth than the indirect method and provides a greater picture of cash flow, but the indirect method is a bit faster — at the expense of providing less information. 

Direct Cash Flow Method

As mentioned above, the direct cash flow method is an in-depth way to calculate cash flow. All actual cash sources and expenditures are added up, including cash from customers and cash paid out to vendors, as well as payroll cash. 

Indirect Cash Flow Method

The indirect cash flow method is where accountants examine and adjust net income by looking at non-cash exchanges, such as from the asset and liability accounts. This method corrects for the inherent nature of accrual accounting, where revenue and payments are recorded when earned instead of when they are received. 

How To Create a Cash Flow Statement

The best way to understand the cash flow statement is to walk through it in an example. Here’s how to create a simple cash flow statement: 

  1. Gather up cash activities from all three categories: operating activities, investing activities, and financing activities. 
  2. Start with the operating activities. Look at the net income on hand for the time selected (month or quarter).
  3. Add in depreciation and any increases in accounts payable.
  4. Subtract out your accounts receivable increases and inventory increases. At this point, you will have the net cash from your operations. 
  5. Turn to the investing activities and look at any equipment purchased during the time selected. Record it as a subtraction. 
  6. Move forward to the financing activities. Are there outstanding loans? If so, make sure to document them as a subtraction. 
  7. You should end up with the cash flow for the time selected.

It may take some time to set up the cash flow statement. Once you understand how to handle it manually, you will not have any problem following your accounting software of choice to generate cash flow statements in the future.

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Phil Cohen

About the author

Philip Cohen is the founder and President of PRN Funding, LLC. PRN Funding is an extraordinarily focused niche player in healthcare funding. With years of…... Read More

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