What Is a Cash Flow Statement, and How Do You Make One?

What is a cash flow analysis?  

A cash flow analysis is the process of interpreting the data in a cash flow statement to assess a business’ liquidity, solvency, and overall financial health. A cash flow statement shows how much cash a company brings in and spends during a particular time frame. It can help business owners determine their companies’ ability to sustain both short and long-term operations. 

The cash flow statement, together with the income statement and balance sheet, is one of the key financial statements used to measure a company's position. It presents a comprehensive picture of a company's strength and profitability, providing critical information for investors, creditors, and management.

Why do you need a cash flow statement?

A cash flow statement can serve several purposes, including helping business owners make financial decisions and helping investors and management assess a company’s financial health. 

A cash flow statement can be used for the following purposes:

1. Reflecting non-cash transaction adjustments. A cash flow statement is necessary because there are several non-cash transactions that a business can potentially engage in. This is especially true for businesses that use accrual accounting since they may be tracking non-cash accounts like accounts receivable, accounts payable, and inventory. 
2. Providing a snapshot of financial activities. A cash flow statement can also be helpful for cash-basis accounting because it will also reflect any loans received as well as assets purchased or sold. This type of accounting gives a picture of a business's finances based on when activities are completed versus when cash outlays are made. 
3. Assessing liquidity. A company can use a cash flow statement to assess liquidity, which is how easily an asset can be converted to cash to cover a company’s debts or other financial obligations. Liquidity can help demonstrate how well a company can meet its short-term liabilities. 
4. Informing financial decision-making. A cash flow statement can help businesses make informed decisions about investments, expenses, and financing. For instance, a company with a profitable income statement but insufficient cash flows is not likely to be a profitable investment, as it will not have the necessary cash to continue operations. Comparing changes in cash flow from one period to the next sheds an important light on the direction a company is headed in.
5. Facilitating comparative analysis. Stakeholders can use a cash flow statement to analyze a company’s financial health by comparing financial performance across periods of time or with other companies.

3 key parts of a cash flow statement

A cash flow statement can help you make business decisions by showing you how much cash operating, investing, and financing activities generate. 

1. Operating activities

Operating cash flow is generated from a business’ core operating activities, and includes revenue and expenses. Cash received from customers and cash paid to suppliers and employees are considered operating cash flow.

2. Investing activities

Investing cash flow is the net cash that comes from acquiring and selling long-term assets and investments. Investing activities can involve purchasing and selling physical property (such as equipment, real estate, and vehicles) or intangible assets (such as patents) and investments.

3. Financing activities

Cash flow from financing activities is generated by activities such as issuing shares and repaying loans and includes debt and equity financing.

Direct vs. indirect cash flow methods

The direct or indirect method may be utilized to prepare the cash flow statement. Under either method, the investing activities and financing sections are identical. The difference between the two methods impacts the operating activities section only.

The following are some of the most common adjustments to net income when calculating cash flow:

• Depreciation. A non-cash expense on the income statement, depreciation is added back to net income for cash flow purposes.
• Accounts receivable. Increases in accounts receivable are deducted from net income, as no cash has been received for these sales. Conversely, decreases to accounts receivable are added back to net income, because they represent cash received.
• Payables. Increases in payables are a non-cash accrual and are added back to net income.
• Inventory. If purchased with cash, an increase in inventory would mean a cash outlay that reduces net income.

Direct method

For the direct method, simply list all cash payments and receipts from operations, such as receipts from the sale of goods or services, payments to suppliers, salary, rent, and other operating expenses.

• Advantage: Provides a clear view of cash inflows and outflows.
• Disadvantage: Can be more complex to prepare due to detailed data requirements.

Indirect method

For the more commonly used indirect method, begin with net income as a starting point and make the necessary balance sheet adjustments to arrive at an accurate cash flow figure. 

• Advantage: Easier to prepare using existing financial data.
• Disadvantage: May be less transparent regarding specific cash transactions.

How to create a statement of cash flows

Here’s a six-step process for creating a cash flow statement. 

Step 1: Gather necessary financial data

The first step is compiling the information you need to populate your cash flow statement. You should obtain your business’ income statement and balance sheet for the relevant period.

Step 2: Determine operating cash flow

Once you’ve established your starting balance, you’ll need to figure out your operating cash flow, which shows you how much cash your business generates from its operations. 

If you’re using the direct method, you will list the actual cash transactions related to revenue and expenses. Keep in mind that the direct method is more straightforward, but often takes longer than the indirect method since you need to subtract all cash disbursements from all cash generated from operating activities.

If you’re using the indirect method, start with the net income from your income statement and adjust for non-cash expenses (such as depreciation and amortization) and changes in working capital (such as accounts receivable, inventory, and accounts payable). Many businesses use the indirect method to determine operating cash flow as it is faster than the direct method.

Step 3: Calculate investing cash flow 

The next step is recording cash flow from investing activities, including purchasing and selling long-term assets such as property and equipment.

Step 4: Calculate financing cash flow

Next, you will need to identify financing cash flow from activities such as issuing stock, repaying loans, or paying dividends. 

Step 5: Calculate net cash flow

Finally, you can determine your net cash flow by adding the operating, investing, and financing cash inflow or outflow for the reporting period. 

The net cash flow shows how much money your business has gained or lost during the relevant period. If your business has a positive cash flow, that means you have more money coming in than going out; if you have a negative cash flow, your business has spent more than it earned. 

Step 6: Verify and analyze the results

Once your cash flow statement is complete, it’s important to review it for accuracy. When you’re sure it’s correct, you can compare the net cash flow with the beginning and ending cash balances on the balance sheet to determine what direction your company is heading and help you make future financial decisions.

Cash flow statement example

A properly created cash flow statement is an important bridge between the income statement and balance sheet and provides critical information for all decision-makers. You should also consider consulting an accountant or bookkeeper when creating financial statements.

Below is an example of a cash flow statement prepared using the indirect method. Although earnings are $250,000, not all of that amount is available for use, as the bottom line shows.

Cash Flow Statement Company ABC

FY Ending Dec. 31, 2024