What is a cash flow statement and how to prepare it?

Apr 05, 2024

Cash flow doesn’t seem like a new word, but understanding it involves more than knowing what the word means. The objective here is to define the “cash flow statement” and all the technicalities related to it.

This might not seem like an intricate and complex concept; however, you may never know what information comes in handy and when. Cash flow and all the intricacies in relation to it can definitely cause some impact on your business. Ensure the impact is a good one. Here is everything you need to know about cash flow statements.

What is a cash flow statement?

There are some basic terms you must understand before reading about cash flow statements. First is cash flow, which means the amount of cash and cash equivalents that move and out of your business.

The second is cash equivalents, which are highly liquid investments that have a maturity period of up to 90 days. The last is cash balance which means the money you have in hand. This is equal to your business’s last month’s cash balance and the current month’s cash flow

If the cash flow of the current month is negative, you would have to subtract it from the balance.

A cash flow statement displays all the information related to your business’s cash flow. This includes inflow (cash received by the company), outflow (payments made by the company in cash), and any other use of cash made by the business.

What is the purpose of a cash flow statement?

The purpose of a cash flow statement is to display a picture of a company’s performance. It is basically a summary of all the cash receipts and payments over a period of time.

Along with this, it also shines a light on the ways a business generates its income and how it is being spent. 

Another purpose of a statement of cash flow is to give lenders or creditors an idea about the potential of the business, whether or not the business can repay the loan amount or for how much loan the business is eligible, and what should be the monthly installments.

If the cash flow statement shows low or negative earnings and more spending, there is a great chance the business wouldn’t get a loan and vice versa for getting a favorable loan. 

Along with this, a cash flow statement is also a reality for the investors of the business or potential investors. A good statement would be an encouragement for them to increase their investments and the other way around if the statement doesn’t show any progress or potential. 

A cash flow statement can be one of the most significant reality checks for a business. Knowing the inflow and outflow of the cash, how it is being spent, where it is being spent, how it is being earned, and what profits the company is earning are tremendous insights.

These insights, in turn, help to make critical business decisions and help in deciding the future of the company.

A cash flow deficit would mean that the business needs to find ways and make amends to cut down its costs, and a cash flow surplus would mean that the business can make new investments and take up new ventures. 

On the basis of the cash flow statement, companies can find out how much revenue is generated by different kinds of activities. Further, they can come up with the best business decisions on the basis of their analysis of the financial statements.

It is important that a firm’s revenue from operating activities should be more than its net income. This is so because a company with a positive cash flow is more likely to flourish in the market. 

A company’s growth is measured in terms of its cash flow and branches. 

It is essential to know that cash flow and profit are two different things. People tend to interrelate these terms, and so a cash flow statement is most of the time shown together with other financial statements, such as an income statement or a balance sheet.

What is the structure of cash flow statements?

To know the structure of cash flow statements, it is essential to know about the activities associated with them. Following are the business activities that are significant constituents of the cash flow statement:

1. Operating activities

Operating activities are a part of cash flow statements. When a cash flow statement is prepared, operating activities are depicted in the initial section. It shows the amount of money flow that comes into the business because of its day-to-day business operations.

In other words, it is the income generated by a business from its ongoing business activities, such as selling, manufacturing, and providing services to customers. Payment of dividends is not considered a part of operating activities.

The main concern of operating activity is the core business. It does not include long-term investments and capital expenditure.

2. Investing activities

When revenue is generated in a business through investments, it becomes a part of investing activities in the cash flow statement. Revenue through investment is generated when businesses sell/purchase their assets

Purchasing assets, long-term investments in government bonds and securities, and selling physical assets are part of investing activities. Through the investing activities section, businesses can learn about their profit and loss ratio of assets and securities.

3. Financing activities

The primary focus of financing activities is to understand the fundraising process of a business and the way it repays to the investors. In short, it is about analyzing the process of raising capital through capital markets.

Financing activities consist of dividend payments, equity issuance and repayment, repayment of debts, and obligations associated with the capital lease.

Cash flow statements are divided into four different parts

The above-mentioned are the business activities associated with cash flow statements. Now, let us understand the structure of a cash flow statement.

1. Cash generated from operating activities

This part of the cash flow statement shows the net income generated by a company. Further, it transforms it to a cash basis which was previously noted on the accrual basis.

This is done by employing the amendment in the balance of current liabilities and current accounts. It includes prepaid insurance, supplies, bills receivable, wages payable, and others.

2. Cash generated from investing activities

When amendments are found in the balances of long-term securities and assets, it is mentioned in this section of the cash flow statement. It includes all the physical assets such as buildings, machinery, land, vehicles, and furniture.

Investing activities include the sale/purchase of assets such as equipment, plant, and property.

3. Cash generated from financing activities

When changes occur in the balances of stockholders’ equity accounts and long-term liabilities, it comes under the section of financing activities in cash flow statements. It includes preferred stock, bonds payable, retained earnings, common stock, and a few others.

To sum up, it includes short-term and long-term repayments and borrowings of a company.

4. Additional information

The payment of income tax by a company and the amount of interest is mentioned in this section. Mostly, businesses use indirect methods to prepare a cash flow statement. If this method is employed, the company's balance sheet differences provide sufficient information.

Example of the Cash Flow Statement

Let us understand the concept of a cash flow statement with an imaginary example.

Assume the cash flow statement of a company XYZ is for a reporting period that ends on March 31, 2020. The opening balance of cash and cash equivalents at the top of the income statement is given as $10.7 billion.

A total of $53.7 billion is generated from the operating activities of the business during the reporting period. The investing activities portion reveals that the business has done investment-related transactions worth $33.8 billion. A total of $16.3 billion is reflected in the financing activities portion due to the activities associated with equity financing and debt.

Towards the end of the cash flow statement, the three portions display an increase of $3.5 billion in cash and its equivalents during that accounting year. Hence, the final balance of cash and its equivalents towards the end of the reporting period reflects $14.3 billion

How to prepare a cash flow statement for your business?

1. Determining the Initial Balance

The initial step involved in the preparation of a cash flow statement is to dictate the initial balance. A company must determine the initial value of cash and its equivalents at the starting point of the reporting statement. This balance can be extracted from the income statement of the associated accounting year.

While employing the indirect method of finding out the income generated from operating activities, mentioning the initial cash balance becomes mandatory. It is not essential to mention this entry if a direct method is employed to calculate cash flow.

2. Calculate cash flow from operating activities

Now, when you have the initial balance, you need to find out the revenue generated from operating activities. This step is significant as it reveals the amount of income generated by a company from its daily operations.

The simple way of finding out cash flow from operating activities is through direct or indirect methods.

Direct Method: The immediate technique for computing income generation from operating activities is an effortless process that includes taking all the money assortments from operations and deducting all the money payments from operations.

This approach records every one of the exchanges that brought about cash paid or received during the reporting time frame.

Indirect Method: To calculate cash flow from operating activities through the indirect method, you need to extract the value of net income. The net income generated by a company is found in the income statement.

To cancel the impacts of the accruals during that accounting period, companies need to make adjustments in the statement. For example, amortization and depreciation need to be adjusted in the accounting report.

Both methods will provide the same output. It is the process involved that is different in the case of the direct and indirect methods.

While the direct method is more prominent, it's additionally tedious in light of the fact that it requires representing each exchange that occurred during the reporting time frame.

Most organizations favor the indirect method of cash flow statement since it's quicker and firmly connected to the monetary record. In any case, the two methods are acknowledged by Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).

3. Calculation of cash flow from investing activities

Once the cash flow from operating activities is calculated, the next step in the cash flow statement is to calculate the cash flow from investing activities.

This portion of the cash flow statement deals with the selling and purchasing of long-term assets such as equipment, properties, and facilities. Debt is not included in cash flow from investing activity.

4. Calculation of cash flow from financing activities

The third segment of the cash flow statement analyzes cash inflows and outflows connected with financing activities. This incorporates incomes from both equity financing and debt — incomes related to raising funds and repaying debts to creditors and investors.


While utilizing GAAP, this segment likewise incorporates payment of dividends, which might be a part of operating activities while utilizing IFRS norms. Interest paid is a part of the operating segment under GAAP, yet now and again in the financing activity under IFRS too.

5. Decide the ending balance

When the revenue generated from the three fundamental kinds of business activities is represented, you can decide the ending balance of cash and its equivalents towards the end of the reporting period.

The adjustment of net income for the period is equivalent to the amount of revenue from operating, investing, and financing activities. This value shows the aggregate sum of income a company acquired or lost during the reporting time frame.

A positive net income demonstrates that a business had more cash flow into it than cash outflow, while a negative net income shows it spent more than it procured.

The final step of preparing the cash flow statement is to find out the net increase/decrease in the cash and cash equivalents of the business during that particular reporting period.

Understanding the limitations of the Cash Flow Statement

Along with advantages, cash flow statements have some limitations as well. The limitations associated with cash flow statements are mentioned below.

1. It cannot reflect Net Profit

The cash flow statement is unable to reflect the net income generated by a business for the accounting period as it excludes items that are non-cash. Such items are taken into consideration by the Profit and Loss Statement.

Also, the cash flow statement does not assist with finding out the profitability of the business because neither revenues nor cost are a part of it. Well, it can be utilized as an add-on to the income statement.

2. Not a substitute for an Income statement or Funds Flow Statement

The Cash flow statement cannot perform the functions efficiently done by the income statement or by the funds flow statement. It is unable to replace these two statements.

3. It is not possible to make Industry Comparison

As the cash flow statement doesn't gauge the effectiveness of the firm, comparison with other inter-industry is beyond the realm of possibilities. A firm having less capital venture will have less cash flow than the business which has more capital investment bringing about higher income generation.

4. It does not correctly assess liquidity position

In a functional situation, the cash flow statement doesn't survey the liquidity or dissolvability position of the firm as it presents a money position just on a specific date. It just assists with understanding what measure of obligation can be met. In a nutshell, it doesn't address the genuine liquidity position.

What tools can support the cash flow and management of it?

Even if you are an entrepreneur, individual contributor, or manager, it is essential for you to understand how to prepare cash flow statements and other financial statements. It is significant for making good business-related decisions.

One of the most critical financial reports to analyze and understand is the cash flow statement of a business. It offers detailed ideas about how a firm generates revenue and spends it. To make better and more straightforward decisions, it is essential to understand the workings of a cash flow statement. 

Remember not to confuse cash flow with profit. These are two different concepts. Cash flow points towards the revenue generated by a firm from its day-to-day operation. On the other side, profit is the reward for bearing risk. 

To make the tracking and management of cash flow a little easier, we introduce to you an all-in-one spending management system — Volopay! For accurate financial planning and decision-making, this is an absolute necessity.

Volopay is a carefully curated system for helping businesses with their financial management.

There are numerous varied features offered, like corporate cards, direct accounting integration, reimbursement module, credit lines, budget enforcement, limit restricting facilities, multi-currency digital wallets, vendor management solutions, real-time transaction tracking, and so much more. 

All the Volopay features can help businesses successfully have transparency over the spending made from the company funds, how much is being earned, the company’s performance in the accounting books, and where cost cuts can be implemented for more efficient business growth.

Frequently Asked Questions
How do accounts payable and accounts receivable related to cash flow?

The main thing to recollect is that accounts payable will diminish your business' income, though accounts receivable will increment it. Assuming the accounts payable have diminished, this implies that money has really been paid to merchants or providers, and subsequently, the organization has less money. Hence, a diminishing in accounts payable demonstrates negative income.

Differentiate Cash Flow Statement vs. Income Statement vs. Balance Sheet

A balance sheet reflects an organization's monetary situation as far as the number of assets it possesses instead of liabilities. A cash flow statement tracks the development of cash, whether approaching or out-flowing, during an accounting period. Income statements and balance sheets give required data to the cash flow statement. Balance sheets reflect what a firm owes and what it possesses at a fixed period of time. Income statements reflect the revenue generated and spent by a company over an accounting period. A cash flow statement is a bit different concept. It reflects the exchange of cash flow between a firm and the market within a fixed point of time.

How is cash flow calculated?

Cash flow is calculated by adding a firm’s depreciation and net income and then deducting the change in working capital and capital expenditure. With the indirect method, cash flow is determined by changing net income by adding or taking away contrasts coming about because of non-cash exchanges. The direct method includes all of the cash receipts and payments, including cash paid to providers, cash receipts from clients, and money paid out in pay rates. This method for Cash flow statements is more straightforward for small organizations that utilize the cash-based bookkeeping strategy.