How to Prepare a Cash Flow Statement : A Complete Guide
A cash flow statement is informative to investors, shareholders, and business owners. It tells them the amount of cash a business received and spent during an accounting period. They need this information to determine the profitability of the business enterprise or company. If you do not have a well-prepared cash flow statement or do not know how to create one, you might not be able to attract your desired investors. If that’s your situation, do not worry; you are about to turn things around. In this article, we will show you how to prepare a cash flow statement.
Meaning of a Cash Flow Statement
A cash flow statement is a systematically prepared report of the movement of cash in and out of a business over a period. It shows where cash is coming from and where it is going to. Hence, it can also be used to create a picture of future cash flows. That is why entrepreneurs and investors can use discounted cash flow (DCF) to determine the value of a company.
The cash flow statement is one of the most frequently used documents for reporting the financial situation of a business. Others include the balance sheet, income statement, and profit and loss account.
Steps to Follow to Prepare a Cash Flow Statement
Now let’s show you how to prepare a cash flow statement. You will need to follow five simple steps, which are as follows:
Step 1: Begin with the starting cash balance
While preparing books of accounts, we take into consideration the accounting period. Every accounting period has a beginning and an end. Similarly, to prepare a cash flow statement, you must determine the balance of cash and cash equivalents at the start of the accounting period. You can find the relevant figure(s) on the income statement for the reporting period.
Step 2: Calculate cash flow from operating activities
Having determined your starting balance, the next step is to look into your operating activities and calculate cash flow from them. It is necessary and important to take this step because it will give you insight into the amount of cash your business is generating from its operations.
There are two methods for calculating cash flows at this stage: direct and indirect. Both methods give the exact figure in the end. While the starting balance is not considered when using the direct method, you will need it for the indirect method. Below is a short explanation of what both methods mean.
- Direct method: The direct method of calculating operating cash flow is used when you want to list all the cash paid out or received from all transactions during the accounting period. It is a simple process that involves adding all the cash received from operations and deducting the cash spent during operations. So, changes in cash receipts and payments are tracked using this direct cash flow method and reported in the cash flow from operations.
- Indirect method: The indirect method of calculating operating cash flow involves making some adjustments, such as depreciation and amortisation, using the net income from the income statement. The adjustments are necessary to remove the impact of the accruals throughout the reporting period. So, the implied cash flow is calculated using this indirect approach, which adds or subtracts changes in the asset and liability accounts from the net income earned over a given period.
Step 3: Calculate cash flow from investment activities
After calculating the cash flow from operating activities, the next step is to calculate the cash flow from investment activities. Here, you need to consider all cash flows during the buying and selling of machinery, facilities, real estate, and other long-term assets. Note that investing activities that involve debt should not be included in this section of the cash flow statement.
Step 4: Calculate cash flow from financing activities
All cash flow from activities relating to the financing of the business should be calculated in this section. They include cash flows associated with investors and creditors, which are equity and debt financing.
Several standards of financial reporting approach this section differently. For example, when using the Generally Accepted Accounting Principles (GAAP) standard, the sum of dividends paid is added in this section. In contrast, it is included in the operating section when following the International Financial Reporting Standards (IFRS).
Step 5: Determine the ending cash balance
The closing balance of cash and cash equivalents at the end of the reporting period is calculated after cash flows from the three primary categories of business activities have been taken into consideration.
The total of the cash flows from operating, investing, and financing activities equals the change in net cash for the accounting period. This figure represents the overall cash flow a business made or lost during the reporting period. If you got a positive net cash flow after carefully following the above steps in your calculation, then your business received more cash than it spent. The reverse will be the case for a business with a negative net cash flow.
Improving Your Cash Flow Statement Preparation
In the process of preparing a cash flow statement for your business, there are a few things you must do to avoid common mistakes. They are as follows:
- Ensure that all accounts are categorised correctly
Ideally, you should be able to follow the examples we have provided in this article to prepare a cash flow statement for your business. However, if you are not conversant with basic accounting, you can discuss your cash flow statement preparation with a financial advisor. This step is necessary because you need to ensure that every cash-related transaction is entered into the correct section of your cash flow statement.
- Ensure that the statement represents actual inflows and outflows of cash
In addition to ensuring that all accounts are well categorised, when preparing a cash flow statement for your business, it is important to make sure that whatever item is not cash or cash-equivalent is excluded from it. You should only include all transactions that have monetary implications during the accounting year. We will now show you what the items that represent actual inflows and outflows of cash are in a cash flow statement.
How Does a Cash Flow Statement Look Like?
Below is an example of the cash flow statement of an imaginary company. The indirect method was used in preparing it.
Now you know how a cash flow statement looks. But let us face the facts: manually preparing a cash flow statement is a demanding forensic activity. Assuming everyone knew how to do accounting and ensure correct bookkeeping, we would all be accountants. Since that is not the case, are there no alternative ways to help accounting novices prepare a cash flow statement? Of course, there are!
Best Apps for Your Cash Flow Statement
Fortunately, you do not have to prepare a cash flow statement by yourself if you are uncomfortable with the process. You may want to contact a professional, such as an accountant, but their services are not usually cheap. Therefore, we decided to help you with our list of the best apps for preparing a cash flow statement and other financial reports for your business. Check them out below and see the benefits they have to offer.
Xero is the best secure cloud-based platform and mobile app for managing your accounts and bookkeeping processes. It is a powerful and simple online accounting software for small businesses. You can use it to see your invoices and accounts online, pay bills, view accounts payable and cash flow, connect to third-party financial tools like PayPal and Stripe, synchronise bank details and financial information, and collaborate with your advisor in real time.
Guess what? Xero allows you to try all its features free of charge for 30 days! You can later subscribe to its various plans for as low as $22 per month. Create an account with Xero now to enjoy all its benefits!
One of the smartest ways to power your business today is to use a tool like Square. There are already millions of diverse brands using this service today. Aside from its suitability for accepting payments safely and building customer relationships for online and in-store businesses, Square can also be used to manage cash flow statement preparation. It provides real-time tracking of cash inflows and outflows through its Square Invoices product. You can also use Square to automatically import your sales, transfers, and refunds into Xero and much other online accounting software.
Tide is an EMI that makes it easy for business owners and managers to do what they love, including accessing real-time cash flow forecasts based on their account activities. It is a simple, powerful, and automated app for all kinds of commercial establishments—freelancers and small businesses inclusive.
You can use Tide to avoid manual accounting and bookkeeping by creating an account with it and connecting your Tide account to Xero or any other accounting software. No matter the scale of your business, Tide has an account plan for you.
Manually managing your company's spending is a very stressful task. In fact, it is an old-school system! Nowadays, smart managers use software like Soldo to get real-time detailed reports on all kinds of spending, including expenses made by credit cards, prepaid cards, e-wallets, email money transfers, and bank payments.
Soldo allows you to create traditional banking statements for a particular date range, monthly, or periodically. It also lets users integrate and synchronise their accounts with other accounting software like Xero, helping them to get clear views of their cash flows and other financial reports.
Monzo is a neobank that has made banking so easy. Aside from allowing its users to spend, save, and manage their money in one place, Monzo also provides integrated accounting services. When you create a Monzo Business Pro account, you can synchronise it with Xero or any other supported accounting software to enable automatic sharing of your everyday transactions, including cash payments and expenses. In that way, it saves you the stress of manually uploading different statements.
Starling Bank has won several awards in the banking industry. It has no branches, yet it provides fully regulated bank accounts and 24/7 customer support to its account holders. This neobank also offers accounting and bookkeeping services for businesses to easily manage their invoices, taxes, bills, and VAT, as well as all kinds of receipts and expenses, including cash flows. These services are available for a small fee of €7/month.
Revolut is a financial super app for money transfers, multi-currency accounts, payroll, team management, crypto services, and everything else in between. It offers tools for invoice and expense management, including real-time tracking of cash flows into and from your business.
Revolut also helps you reduce human errors in bookkeeping. It gives you access to its automated tools so that you do not have to prepare your statements or financial reports yourself. Besides, you can also enjoy synchronising your account with a leading accounting app like Xero.
There are three formulae you need to remember when preparing a cash flow statement. They are as follows:
- Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.
- Free Cash Flow = Net Income + Depreciation or Amortisation – Change in Working Capital – Capital Expenditure.
- Cash Flow Forecast or Ending Cash = Beginning Cash + Projected Inflows – Projected Outflows
A company that needs to prepare its cash flow statement can use either the direct method or the indirect method. The former involves the use of gross cash receipts and gross cash payments in its preparation, while the latter requires you to start with the net income and subtract or add the decreases and increases in cash flows.
The three types of cash flows are those associated with operating, investing, and financing activities. They are all shown in a cash flow statement.
All cash transactions linked with a business’ main activities are categorised as operating cash flows; those linked with its investments are included in the investing activities; those that have to do with the issuing of debt and equity are financial cash flow activities.
Use the formula below when you want to calculate cash flow from operating activities:
Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.
There are two methods to calculate cash flow when preparing a cash flow statement. They are direct cash flow and indirect cash flow.
It takes being familiar with how to use both methods to know which is easier for you. However, most people prefer the direct method because it is straightforward and does not require any adjustments.
The main purpose of preparing a cash flow statement is to show the availability of cash in any business at the end of an accounting period by looking at its inflow and outflow of cash. It can also be used to forecast the future cash position of the business.
To prepare a cash flow statement in Microsoft Excel, you need to use simple commands, such as SUM. Here is our Excel template, which you can download and edit to prepare your cash flow statement. We have included all the necessary formulae to make the process easy for you.
The main components of a cash flow statement are operating cash flows, investing cash flows, and financing cash flows.
Having read this article, we hope that you now have a clear understanding of how to prepare a cash flow statement and have found a digital tool you can easily use to create it. Always remember to use the cash flow statement examples and apps we have discussed here. Bookmark this article in your browser so that you can quickly access it for reference later.