Cash flow statements are one of the three fundamental financial statements financial leaders use. Along with income statements and balance sheets, cash flow statements provide crucial financial data that informs organizational decision-making. While all three are important to assessing a company’s finances, some business leaders might argue that cash flow statements are the most important.
Business owners, managers, and company stakeholders use cash flow statements to better understand their companies’ value and overall health and guide financial decision-making. Regardless of your position, learning how to create and interpret financial statements can empower you to understand your company’s inner workings and contribute to its future success.
Here’s a look at what a cash flow statement is and how to create one.
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A cash flow statement is a financial report that details how cash entered and left a business during a reporting period.
According to the online course Financial Accounting: “The purpose of the statement of cash flows is to provide a more detailed picture of what happened to a business’s cash during an accounting period.”
Since cash flow statements provide insight into different areas a business used or received cash during a specific period, they’re important financial statements for valuing a company and understanding how it operates.
A typical cash flow statement comprises three sections: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities.
If you’re wondering how to make a cash flow statement, these steps can guide you through the process, from gathering initial data to calculating the final cash balance.
The first step in preparing a cash flow statement is determining the starting balance of cash and cash equivalents at the beginning of the reporting period. This value can be found on the income statement of the same accounting period.
The starting cash balance is necessary when leveraging the indirect method of calculating cash flow from operating activities. However, the direct method doesn’t require this information.
Once you have your starting balance, you need to calculate cash flow from operating activities. This step is crucial because it reveals how much cash a company generated from its operations.
Cash flow from operations are calculated using either the direct or indirect method.
The direct method of calculating cash flow from operating activities is a straightforward process that involves taking all the cash collections from operations and subtracting all the cash disbursements from operations. This approach lists all the transactions that resulted in cash paid or received during the reporting period.
The indirect method of calculating cash flow from operating activities requires you to start with net income from the income statement (see step one above) and make adjustments to “undo” the impact of the accruals made during the reporting period. Some of the most common and consistent adjustments include depreciation and amortization.
The direct and indirect methods will result in the same number, but the process of calculating cash flow from operations differs.
While the direct method is easier to understand, it’s more time-consuming because it requires accounting for every transaction that took place during the reporting period. Most companies prefer the indirect method because it's faster and closely linked to the balance sheet. However, both methods are accepted by Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
After calculating cash flows from operating activities, you need to calculate cash flows from investing activities. This section of the cash flow statement details cash flows related to the buying and selling of long-term assets like property, facilities, and equipment. Keep in mind that this section only includes investing activities involving free cash, not debt.
The third section of the cash flow statement examines cash inflows and outflows related to financing activities. This includes cash flows from both debt and equity financing—cash flows associated with raising cash and paying back debts to investors and creditors.
When using GAAP, this section also includes dividends paid, which may be included in the operating section when using IFRS standards. Interest paid is included in the operating section under GAAP but sometimes in the financing section under IFRS.
Once cash flows generated from the three main types of business activities are accounted for, you can determine the ending balance of cash and cash equivalents at the close of the reporting period.
The change in net cash for the period is equal to the sum of cash flows from operating, investing, and financing activities. This value shows the total amount of cash a company gained or lost during the reporting period. A positive net cash flow indicates a company had more cash flowing into it than out of it, while a negative net cash flow indicates it spent more than it earned.
Understanding cash flow statements can help you manage your business's finances by revealing not just the amounts but also the sources and uses of cash. To help visualize each section of the cash flow statement, here’s a cash flow statement example of a fictional company generated using the indirect method.
This cash flow statement is for a reporting period that ended on Sept. 28, 2019. As you'll notice at the top of the statement, the opening balance of cash and cash equivalents was approximately $10.7 billion.
During the reporting period, operating activities generated a total of $53.7 billion. The investing activities section shows that the business used a total of $33.8 billion in transactions related to investments. The financing activities section shows that a total of $16.3 billion was spent on activities related to debt and equity financing.
At the bottom of the cash flow statement, the three sections are summed to total a $3.5 billion increase in cash and cash equivalents over the course of the reporting period. Therefore, the final balance of cash and cash equivalents at the end of the year equals $14.3 billion.
The balance sheet and cash flow statement are fundamental tools in financial analysis. However, these documents serve distinct purposes and offer different insights into your organization's financial health.
A balance sheet provides a snapshot of a company's financial position at a specific point in time, detailing assets, liabilities, and shareholders' equity. As a result, it offers an overview of what a company owns and owes. In contrast, a cash flow statement focuses specifically on the movement of cash within an organization over a reporting period, categorizing cash activities into operating, investing, and financing activities.
Therefore, the cash flow statement is crucial for understanding the liquidity and operational efficiency of the business, which is vital for day-to-day operations and strategic planning.
Understanding how to create, interpret, and effectively use financial statements is pivotal for strategic decision-making. Financial statements, particularly, are essential tools that extend beyond simple record-keeping that can guide your business strategy.
The cash flow statement is crucial because it delves into how a company manages its cash—detailing how cash is generated from everyday operations, how it’s reinvested back into the business, and how it’s allocated in financing efforts. These insights are indispensable for evaluating a company’s liquidity and financial agility.
Understanding the cash flow statement is key to answering vital business questions, such as:
By learning how to create and analyze cash flow statements, you can make better, more informed decisions, regardless of your position.
Are you interested in gaining a toolkit for making smarter financial decisions and the confidence to clearly communicate them to key stakeholders? Explore Financial Accounting—one of three courses comprising our Credential of Readiness (CORe) program—to discover how you can unlock critical insights into your organization’s performance and potential. Not sure which course is right for you? Download our free business essentials flowchart.
This post was updated on June 13, 2024. It was originally published on December 7, 2021.
Year Ended September 28, 2019 (In millions)
Cash and cash equivalents, beginning of the year: $10,746
| Activity | Amount |
|---|---|
| Net Income | 37,037 |
| Adjustments to Reconcile Net Income to Cash Generated by Operating Activities: | |
| Depreciation and Amortization | 6,757 |
| Deferred Income Tax Expense | 1,141 |
| Other | 2,253 |
| Changes in Operating Assets and Liabilities: | |
| Accounts Receivable, Net | (2,172) |
| Inventories | (973) |
| Vendor Non-Trade Receivables | 223 |
| Other Current and Non-Current Assets | 1,080 |
| Accounts Payable | 2,340 |
| Deferred Revenue | 1,459 |
| Other Current and Non-Current Liabilities | 4,521 |
| Cash Generated by Operating Activities | 53,666 |
| Activity | Amount |
|---|---|
| Purchases of Marketable Securities | (148,489) |
| Proceeds from Maturities of Marketable Securities | 20,317 |
| Proceeds from Sales of Marketable Securities | 104,130 |
| Payments Made in Connection with Business Acquisitions, Net of Cash Acquired | (496) |
| Payments for Acquisition of Intangible Assets | (911) |
| Other | (160) |
| Cash Used in Investing Activities | (33,774) |
| Activity | Amount |
|---|---|
| Dividends and Dividend Equivalent Rights Paid | (10,564) |
| Repurchase of Common Stock | (22,860) |
| Proceeds from Issuance of Long-Term Debt, Net | 16,896 |
| Other | 149 |
| Cash Used in Financing Activities | (16,379) |
Increase / Decrease in Cash and Cash Equivalents: 3,513
Cash and Cash Equivalents, End of Year: $14,259
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