How to Prepare and Interpret a Cash Flow Statement

Cash Flow is the net amount of cash and cash-equivalents being transferred in and out of a company. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.

Think of this as something like a checkbook in nature – the cash flow statement confirms that all the other data on the statements mentioned above is as accurate as possible. The relationship you have with vendors and suppliers is the most important factor in managing accounts payables. To generate credibility with vendors and reduce expenses, pay invoices on time and take advantage of early payment discounts. For example, you might sign long-term contracts in exchange for lower prices. The Small Business Administration recommends using a 12 month cash flow statement using the direct method. We’ll cover all three in detail below, including how to prepare a cash flow statement, how to create a cash budget, and how to prepare a cash flow analysis.

What Goes in a Cash Flow Statement?

Cash flows from financing activities illustrate the inflows and outflows of cash to finance the company from creditors and owners. Inflows are cash received from borrowing on notes, mortgages, and bonds from creditors, or issuing stock to owners. Outflows are cash paid for repayment of principal to creditors, repurchasing stock from owners, or dividends to owners. Just like how a bank statement shows all the money coming in and going out of your account, a cash flow statement shows all the money coming in and going out of a company’s account.

Consider flexible ways to finance long-term and capital-intensive assets such as equipment and facilities. Furthermore, depending on the market and the stability of your business, you may be better off purchasing real estate and making mortgage payments than being locked into a long-term lease. A healthy cash flow depends on the turnover of inventory for which the cash outlay has already been incurred. Identify industry norms for inventory turnover and discount any inventory that exceeds that average or bundle with other products and services to move them off your balance sheet.

Understanding Positive Cash Flow: 3 Types of Cash Flow

Further, if a business doesn’t have enough cash flow to cover current obligations, it won’t be able to obtain credit. Therefore, generating sufficient cash flow from daily operations and managing those cash flows well are critical to supporting future growth. If the cash flow from financing activities is positive, it means that more money is coming into the company than the amount that is leaving the company. A negative free tutoring invoice template cash flow from financing activities could either mean that the company is repaying debt or that it is paying dividends and repurchasing stock. On the other hand, positive cash flow enables businesses to pay suppliers, employees, and creditors on time. It also provides a financial cushion for unexpected expenses or future investments in the business, empowering them to take advantage of growth opportunities.

Essentially, the accountant will convert net income to actual cash flow by de-accruing it through a process of identifying any non-cash expenses for the period from the income statement. The most common and consistent of these are depreciation, the reduction in the value of an asset over time, and amortization, the spreading of payments over multiple periods. Loans for operating production inputs e.g. cotton for the Cotton Company of Zimbabwe (COTCO) and beef for the Cold Storage Company of Zimbabwe (CSC), are assumed to be self-liquidating. In other words, although the inputs are used up in the production, the added returns from their use will repay the money borrowed to purchase the inputs, plus interest. Astute managers are also expected to have figured in a risk premium and a return to labour management. On the other hand, loans for investment capital items like machinery are not likely to be self-liquidating in the short term.

What is Cash Flow?

When recording cash flow from investing on a cash flow statement, businesses will subtract the cash outflow from investing activities from the total cash flow. For example, when a business raises a new round of capital from investors, that shows as a cash inflow because the company has more liquid funds. When these investors are paid back, the statement shows a cash outflow because money left the business. To help you understand the cash flow statement, let’s break down the terminology within each statement. The cash account has money that is available immediately, unlike other asset accounts (i.e., accounts receivable, investments, prepaid expenses, and inventory). No matter what type of cash flow equation you run, the core formula is the same.

Cash flows can be analyzed using the cash flow statement, a standard financial statement that reports on a company’s sources and usage of cash over a specified time period. Corporate management, analysts, and investors are able to use it to determine how well a company can earn cash to pay its debts and manage its operating expenses. The cash flow statement is one of the most important financial statements issued by a company, along with the balance sheet and income statement. Solvency refers to a state where assets (inventory, receivables, equipment, etc.) of the company are sufficient to cover its long-term liabilities (term loans, taxes, interest due, etc.).