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What is a Cash Flow Statement? Understanding, Creating, and Analyzing Cash Flow in Your Business

employee reviewing a cash flow statement

Cash is the lifeblood of a thriving business. Companies that manage cash well can pay bills on time, demonstrating strong financial solvency and securing the ability to borrow cash in the future if needed. Companies with poor cash management can incur costly penalties and late fees, and jeopardize relationships with employees, suppliers, and investors.

Cash flow statements are a critical tool for helping businesses to keep a close eye on cash management. Understanding what a cash flow statement is, how to prepare cash flow statements, and how to analyze a cash flow statement for making strategic business decisions is crucial to operating a successful and financially healthy business.

What is a cash flow statement?

A cash flow statement is an itemized listing of cash-based financial transactions within a business for a specified period of time. This financial statement can be useful for many types of business stakeholders, including managers, business owners, and investors. Within a cash flow statement, any and all cash transactions are categorized and itemized to show how cash was used during the period in review.

Why is a cash flow statement prepared?

Cash flow statements can be prepared for a variety of reasons, but most importantly they are a tool for stakeholders to evaluate the financial stability of a business. Internal stakeholders, such as owners or managers, use cash flow statements to set budgets, evaluate operations, make future projections, and plan large expenditures. External stakeholders, such as investors or loan officers, use cash flow statements to assess a company's financial health and calculate financial risk.

What is in a cash flow statement?

A cash flow statement shows the change in a business's cash balance during a specific period of time. Cash flow statements are typically prepared monthly, quarterly, or annually. A well-prepared cash flow statement can show if the business made or lost money from normal operations, if the business borrowed or lent money, how much debt the business repaid, and more. Each of these actions is categorized into operating activities, investing activities, and financing activities. In addition, some cash flow statements include non-cash activities such as depreciation or bad debt write-offs.

Operating activities

Operating activities include any cash that is generated from or spent to produce a company's products or services. These include sources and uses of cash such as:

  • Receipts from sales of goods and services
  • Purchase of inventory and supplies
  • Interest payments related to operation of business
  • Income tax payments
  • Salary and wage payments
  • Rent payments

Investing activities

Investing activities include any cash used or brought in from a company's investments. These include sources and uses of cash such as:

  • Purchase or sale of assets, including property or equipment
  • Purchase or sale of stock shares and other securities for investment purposes
  • Loans made to vendors

Financing activities

Financing activities include any cash from investors or banks, as well as cash paid to shareholders, activity between its business and owner and the business and its creditors. These include sources and uses of cash such as:

  • Payment of dividends to company stockholders
  • Payments of stock repurchases from stockholders
  • Cash inflows from loans received from investors
  • Cash proceeds from issuance of stock
  • Repayment of loans from investors

How to prepare a cash flow statement

The basic structure of a cash flow calculation is Beginning Cash Balance + Cash Inflow – Cash Outflow. The cash flow statement outlines specific activities in each of these categories, and after the cash inflows and outflows are outlined, total outflows are subtracted from total inflows to get a net cash flow value. This bottom-line number can help determine when and where liquid funds are being used in your business.

Beginning cash balance

To start building a cash flow statement for your business, calculate your beginning cash balance. This is a summation of all company bank balances plus any petty cash on hand. If you've prepared cash flow statements in the past, your beginning cash balance should match the ending cash balance from the previous period's cash flow statement.

Cash inflow

The next step is to itemize all cash inflows for the period by listing all cash receipts. Sources of cash within a period can include:

  • Sales received in cash (sales received on credit are not itemized in a cash flow statement until the funds are actually received)
  • Customer payments on previously financed orders
  • Interest earned on financial accounts
  • Loan proceeds taken for the business
  • Supplier refunds
  • Cash sales of assets

Cash outflow

After itemizing cash inflows, you must itemize all cash outflows for your business. Cash outflows will include any cash used to grow or maintain the business. Uses of cash can include:

  • Payments to suppliers or vendors
  • Employee salaries
  • Interest paid on outstanding business loans
  • Taxes
  • Purchase of property or other business assets
  • Purchase of supplies or materials
  • Loans given to other firms

Analyzing cash flow: How to understand a cash flow statement

Once your cash flow statement is generated, it shouldn't sit on the shelf only to be pulled out at the request of a potential investor. Cash flow statements are powerful tools for analyzing the financial health of your business. By taking proactive steps to understand how your business uses cash from period to period and identifying which sources and uses of cash are most profitable, you can make strategic business decisions that continue to bring in cash when you need it.

1. Distinguish between sales and cash flow

Even if your business is bringing in sales, that doesn't necessarily indicate you'll have available funds on hand to pay bills when they're due. Sales do not always equate to cash in the bank, especially if your business operates by extending large amounts of credit to customers. Cash flow statements can help you more easily see if your business is collecting on outstanding credit accounts and not extending more credit that your business can handle. Understanding this important distinction can help you enjoy good business credit by ensuring there is plenty of cash on hand to pay your bills on time and keep your business afloat.

2. Analyze historical cash flow data

Historical cash flow data can be a solid indicator of a business's solvency and can help dictate future cash flow actions. By looking back at previous cash flow decisions and comparing your company's cash position from period to period, you can gauge the effectiveness of your operational and investment decisions. Furthermore, if your business has public investors, they will likely expect some historical documentation on how and where their investment in your business is being spent.

3. Forecast future cash flow projections

In addition to reviewing historical data, making future cash flow projections can help you maintain a healthy cash flow position for your business. These projections will include not only your expected sales but also projected expenses and other cash payouts, including stockholder payments. By projecting your cash flows at least 12 months ahead, you can identify any cash trouble spots and take steps in advance to mitigate them, minimizing the need for unnecessary or costly cash advances.

4. Evaluate your financial tracking methods

Although cash flow statements follow the same general format, not all cash flow statements are prepared following the exact same methods. Different businesses have different operational strategies, and an activity that may be an operating expense for one company could be classified as a financing activity for another.

Explore your current financial tracking strategies and verify that your methods are providing the clearest picture of the cash flow health of your business. The two most common financial tracking methods are:

  • Direct — This method tracks basic inflows and outflows of operating activities only. It's the easiest to start for newer business owners but doesn't provide as much transparency for more complicated businesses.
  • Indirect — This method tracks specific activities from all three types of cash flow activities, as well as asset depreciation and net income. While this method is more complicated to learn and time-consuming to track, it provides much more detail for business owners and investors.

5. Change customer payment and collection strategies

When evaluating your financial tracking methods, you may discover that your business could benefit from changes to its operational processes. If you identify that your customers typically take a long time to pay outstanding invoices, you may take steps to speed up the customer collection process. Instead of billing for goods and services, make it easy for customers to pay immediately by check, credit/debit card, or electronic payment options. Authorize your employees to accept payments on the fly with mobile devices, and incentivize early payment on customer invoices by offering a small percentage discount when customers pay at least 7 days before the invoice due date. All of these steps can help you put sales on a more equal footing with your cash flow.

6. Change business income and expenses

While it might feel like you have little control over sales or expenses, you can positively impact your cash flow statement by getting more cash income or reducing cash expenses. Start looking for potential opportunity areas by examining your:

  • Business plan — Adjusting your hours of operation, dropping unprofitable product or service lines, or expanding into new markets are all changes to your business plan that could result in increased sales or decreased expenses.
  • Budget — Examining your line-item variable costs could reveal opportunities for reducing expenses, such as marketing or travel.
  • Customer list — If you have customers who consistently pay bills slowly or create cash flow issues for you, it may be time to cut ties with them. Likewise, opening the door for conversations with your existing customers may help you identify new opportunities for increased revenue.

Conclusion

Cash flow sounds simple, but managing it wisely is a complex endeavor. Failure to properly track, analyze, and predict your business cash flows can result in cash shortages, which can cause problems making payroll, disrupt relationships with your vendors, and result in unneeded stress and frustration. Taking steps to learn how to properly craft and analyze cash flow statements can help ensure the longevity of your business and minimize avoidable frustrations.

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* This content is for educational purposes only, is not intended to provide specific legal advice, and should not be used as a substitute for the legal advice of a qualified attorney or other professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up-to-date.

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