A cash flow statement is a financial document that tracks actual cash entering and leaving a business over a period of time. A cash flow statement is one of the three key financial statements, alongside the income statement and balance sheet.
There are actually two ways to do a cash flow statement. The first method is the cash method, where revenue and expenses are only recognized when cash is received or paid out, respectively. The second method is the accrual method, where revenue is recognized when it is earned, and same with expenses. The cash method is no different than an income statement, so in finance a ‘cash flow statement’ refers to the accrual method.
There are three parts of a cash flow statement: cash flow from operating activities, investing activities, and financing activities.
1. Operating Activities
A cash flow statement can be written one of two ways, the only difference existing within the operating activities section.
Direct Method
The direct method involves directly the sources of cash. This is usually used by smaller companies, as it is easier to list out all cash expenses for these kinds of firms. Here are some examples of cash categories to consider:
Cash receipts from customers
Cash paid to suppliers
Cash paid to employees
Cash paid for interest
Cash paid for taxes
Indirect Method
The indirect method has three steps:
Start with the net profit/loss of the business. You can find this from the income statement.
Add back all the non-cash expenses, since they need to be removed from the net profit. Some examples are depreciation and amortization, or a gain/loss on the sale of non-current assets. Subtract any gains, add any losses.
Adjust for the movement in working capital. These include the increases or decreases in inventory, receivables, and payables. For inventory and receivables, subtract out any increases and add any decreases from the total. For payables, vice versa.
The reason the indirect method is more popular amongst accountants and bookkeepers is because it is hard to analyze and track every single cash transaction from your business. The higher the transaction volume, the more tedious this process is for your business. The indirect method is more efficient, and a lot of the data necessary comes straight from your income statement or balance sheet.
Here is an example:
Direct vs. Indirect Method (Operating Activities)
2. Investing Activities
Cash flow from investing activities include the purchase or sale of long term assets. Subtract out any purchases, and add back all sales.
3. Financing Activities
There are two types of cash flow from financing activities:
Liabilities: Simply put, how much debt the company is in. This involves how much debt you current own (add to total cash) and how much debt you have paid off (subtract from total cash).
Equity: Capital contributions from shareholders. Issuing stock is a cash inflow (add to total), and paying dividends is a cash outflow (subtract from total).
Here is what it looks like all together, using the indirect method for Operating Activities:
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