Cash flow statement: a comprehensive guide to reading and preparing one

Unlike income statements and balance sheets, which may include non-cash items, the cash flow statement offers a clear view of the actual cash that flows into and out of your business over a specific period.
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Having a firm grasp on how to read and prepare a cash flow statement can help you manage your company's liquidity effectively, ensure you can meet obligations, and invest in future growth opportunities.
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Access Ramp's free PDF example and template of the cash flow statement in our Accounting Documents Library. 

What is a cash flow statement?

A cash flow statement (CFS), also known as a statement of cash flows, is a financial document that provides a detailed summary of a company's cash inflows and outflows over a specific period. It offers valuable insights into a company's liquidity by showing how well it generates cash to fund its operating expenses, pay debts, and support investments.

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While income statements and balance sheets offer views into a company's profitability and financial position, they often include non-cash items and do not provide the full picture of cash movements.

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The cash flow statement, on the other hand, focuses solely on actual cash transactions, giving a clear perspective on a company's ability to sustain operations, meet financial obligations, and plan for future growth. Understanding concepts like free cash flow can further enhance insights into your company's financial health.

What is the purpose of a cash flow statement?

A cash flow statement is not just a financial reporting requirement; it's a vital tool for effective financial management. The cash flow statement provides a clear picture of your company's liquidity, which is essential for effective liquidity management. It shows how much cash is available to meet short-term obligations and operational expenses.

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The cash flow statement helps you forecast future cash positions, plan for significant expenses, and make informed decisions about investments and financing needs. Regularly reviewing your cash flow statement can help you spot trends or potential problems early, such as declining cash from operations or increasing reliance on external financing.

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Lenders, investors, and partners often require cash flow statements to assess your company's financial health and risk profile. A well-prepared cash flow statement demonstrates transparency and sound financial management.

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Finally, understanding your cash flow through regular cash flow analysis helps you make strategic decisions, such as timing major purchases, adjusting credit terms, or exploring opportunities for growth.

How to read a cash flow statement

A cash flow statement is divided into three main sections, each representing different types of cash activities:

1. Cash flow from operating activities

This section details cash transactions resulting from a company's primary business operations. It includes cash received from customers for sales of goods or services and cash paid to suppliers and employees for operating expenses. It may also include cash paid or received for interest and taxes.

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For example, cash inflows might include cash received from customers, while cash outflows might include payments for inventory, salaries, rent, and utilities.

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This section is crucial because it indicates whether a company can generate sufficient cash from its core business operations to maintain and grow its operations without needing external financing.

2. Cash flow from investing activities

This section reports cash transactions involving the purchase or sale of long-term assets and investments. This includes cash paid to acquire property, plant, and equipment (capital expenditures), and cash received from the sale of assets or investments.

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For example, if a company purchases new equipment, the cash used is reported as a cash outflow under investing activities. Conversely, if it sells a piece of equipment or an investment, the cash received is reported as an inflow.

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This section helps stakeholders understand how a company is investing in its future growth and maintaining its asset base.

3. Cash flow from financing activities

This section reflects cash transactions that affect a company's equity and borrowings. It includes cash received from issuing stocks or bonds, cash paid out as dividends, and cash used to repay debts or repurchase shares.

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If a company raises cash by issuing new shares or taking out a loan, these are cash inflows under financing activities. Paying dividends to shareholders or repaying a loan are cash outflows.

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This section provides insight into how a company funds its operations and growth through external sources of capital.

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Note that the data presented on a cash flow statement may differ from that on a balance sheet or income statement due to factors like revenue recognition methods or the impact of non-cash expenses such as depreciation.

Methods of preparing a cash flow statement

There are two primary methods used to prepare the cash flow statement: the direct method and the indirect method. Both methods are accepted under U.S. Generally Accepted Accounting Principles (GAAP) and, when applied correctly, should result in the same net cash flow from operating activities.

Indirect method

The indirect method starts with the net income from the income statement and adjusts for changes in balance sheet accounts to convert the company's net income from an accrual basis to a cash basis.

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This involves adding back non-cash expenses such as depreciation and amortization and adjusting for changes in working capital accounts like accounts receivable, inventory, and accounts payable.

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Here’s an example:

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If a company has a net income of $100,000, depreciation expense of $10,000, an increase in accounts receivable of $5,000, and an increase in accounts payable of $3,000, the cash flow from operating activities would be calculated as:
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• Net Income: $100,000
• Add back depreciation expense: +$10,000
• Subtract increase in accounts receivable: -$5,000
• Add increase in accounts payable: +$3,000
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Net cash provided by operating activities: $108,000

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‍The indirect method is widely used because it is straightforward to prepare from the existing financial statements and aligns with accrual accounting. 

Direct method

‍The direct method involves listing all cash receipts and cash payments from operating activities. This method shows the specific cash inflows and outflows, such as cash received from customers and cash paid to suppliers and employees.

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‍For example:
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• Cash received from customers: $200,000
• Cash paid to suppliers: -$80,000
• Cash paid to employees: -$50,000
• Cash paid for operating expenses: -$20,000
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Net cash provided by operating activities: $50,000
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‍The direct method provides more detailed information about cash transactions but can be more time-consuming to prepare since it requires tracking all cash receipts and payments. Both methods have their advantages, and the choice often depends on the company's preference and the availability of detailed cash transaction records.

How to prepare a cash flow statement in 5 steps

For very small companies, there may be some months or quarters where there is no cash flow from operating or investing activities. Depending on the size of a company and the complexity of the business, its cash flow statement could fit on just one page, or span multiple pages with dozens of line items. Here’s how you can prepare a cash flow statement:

Step 1: Determine the starting cash balance

Begin by identifying the cash balance at the start of the period you're reporting on. This figure is typically found on your company's balance sheet under cash and cash equivalents. This starting point allows you to track changes over the reporting period.

Step 2: Calculate cash flow from operating activities

Using either the direct or indirect method (as described above), calculate the net cash provided by or used in operating activities. This involves accounting for cash receipts from customers and cash payments for expenses like salaries, rent, and utilities. Adjust for changes in working capital accounts if using the indirect method.

Step 3: Calculate cash flow from investing activities

Next, record cash transactions involving the purchase or sale of long-term assets and investments. Include cash paid to acquire assets like equipment or property (cash outflows) and cash received from the sale of assets or investments (cash inflows).

Step 4: Calculate cash flow from financing activities

Calculate cash flows from financing activities by accounting for cash transactions that affect equity and borrowings. This includes cash received from issuing stocks or bonds (inflows), cash paid out as dividends, and repayments of loans or repurchase of shares (outflows).

Step 5: Compute the ending cash balance

Add the net cash flows from operating, investing, and financing activities to the starting cash balance. The result is the ending cash balance for the reporting period, which should match the cash and cash equivalents on your balance sheet at the end of the period.
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Starting Cash Balance

+ Net Cash from Operating Activities

+ Net Cash from Investing Activities

+ Net Cash from Financing Activities

= Ending Cash Balance
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Track and control your cash flow with Ramp

While manually building a cash flow statement is a helpful exercise, it’s also timely and inefficient. Luckily you don’t need to be an accounting whiz or Excel expert to build one or use it to manage your software.

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Using accounting and expense management software like Ramp makes this process fast and reliable. The digital transformation of accounting tools and the advent of finance automation makes it easy for you to level up your finance function and scale your business more effectively.

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Ramp can centralize the records of your company's transactions, making expense recognition and the creation of financial documents much easier. Automating expense management and recognition can also make your accounting team more efficient, freeing up team members to focus on more high-value projects. Implementing these tools can be a significant step toward improving cash flow and ensuring the financial health of your business.