The cash flow statement: what is it and how is it made?

What is a cash flow statement?: Definition and example

October 28, 2022
5 minutes read

The cash flow statement is one of the most important financial statements for small business owners. It helps to reconcile the numbers in your bank account with your actual income and spending, so you can better understand how cash moves through your business and if you’re managing your money effectively. 

Before we get too ahead of ourselves, let’s define what a cash flow statement actually is. Simply put, a statement of cash flows is a financial report of every transaction where your business earned or spent cash or cash equivalents within a certain period of time

Unfortunately, most small business owners don’t know what goes into a statement of cash flows—or how to read one, for that matter. It’s important to get ahead of the curve and get familiar with cash flow statements, since 30% of small business failures can be traced back to cash flow struggles (yikes!). 

But don’t worry, we’ll help you get there. In this article, we break down the five main aspects of every cash flow statement and teach you how to better understand the information it gives you. We also share an example you can use to build and forecast your own statement of cash flows. Let’s get into it!

What is a cash flow statement used for?

So, what is a cash flow statement and what is it used for? To recap, a cash flow statement tells you how much cash you have on hand for a certain period. This refers to real cash that flowed into or out of your bank account, so it doesn’t include things like:

  • Invoices you sent that haven’t been paid yet
  • Invoices you received but haven’t paid

Your statement of cash flows summarizes cash transactions over a set period of time (often a month, quarter, or year), so you get a picture of how cash moves through your business and how irregular income and expenses affect the cash you have available. Cash flow statements help you evaluate your business’s financial operations, pay off debts, and determine how much cash you have on hand. 

Your statement of cash flows are used to tell tell you things like:

  • How long funds from a small business loan will last you and whether or not your business can sustain itself once you deplete the loan
  • If the payment terms you extend to customers may lead to cash flow problems down the road
  • If you can really afford to invest in new equipment (like a laptop or home office furniture)

How to make a cash flow statement

The statement of cash flows looks different, and varies in complexity, from one business to another because your spending and revenue are unique to you. That said, every statement of cash flows involves five main components:

  • Net income (which is taken from your income statement)
  • Operating cash flow
  • Cash flow from investing
  • Cash flow from financing
  • Net cash flow

Net income

Net income is one of the financial terms most familiar to business owners. You may also call it “profit” or your “bottom line,” and it’s the starting balance we’ll use for your cash flow statement. You’ll find net income listed on your income statement, and it’s calculated by subtracting your business expenses from total revenue or sales.

Every statement of cash flows starts with net income—but net income includes transactions that don’t involve cash changing hands. That’s why the rest of your cash flow statement will adjust your net income to account for non-cash transactions like depreciation, revenue earned but not yet received, and expenses incurred but not yet paid.

Cash from operating activities

The next section of your statement of cash flows is often the most important section for small businesses. Cash flow from operations is one of the best indicators of your business’s financial health since it summarizes the cash flow that happens from your actual business operations—so, the things your business does every day, like selling goods and services.

For example, if you’re a freelance graphic designer, this section records the money you earned and expenses you incurred by regularly doing graphic design for clients.

The operating cash flow section includes things like cash inflow from invoice payments and cash outflow to cover:

  • Cost of goods sold (COGS)
  • Marketing and advertising
  • Employee salaries or payments to contractors
  • Other overhead and administrative expenses

You can either use the direct method or the indirect method to calculate your cash flow from operations (but more on that later!). 

Let’s go back to our freelance graphic designer friend now—here’s an example of how she would calculate her cash flow from operations. Her net cash flow from operations for the quarter may look like this:

[$10,000 in paid revenue] – [$0 in COGS] – [$100 spent on marketing] – [$700 paid to a virtual assistant] = Net Cash Flow from Operations of $9,200

Cash from investing activities

The next section of the statement of cash flows summarizes the investments your business has made—either into itself or into other businesses. It doesn’t involve investments someone else makes into your business (those are recorded in the financing section).

For example, if you invest in a new laptop, that expense is categorized as a cash outflow for investing in the business.

This section is important because it can help explain deviations in your normal cash flow. In the month you purchase that laptop, your net cash flow may be lower than normal—but you know that isn’t cause for concern because the cash was used to invest back into the business. If a faster computer makes you more productive, it may even increase net cash flow in the future.

On the flipside, if you previously purchased office space and you decide to sell it, the income from that sale goes in this section, too. In that case, understanding that that revenue isn’t part of your typical cash inflow can help you better predict future cash flow and manage your spending accordingly.

Cash from financing activities

Cash flow from financing is the third and final body section of the statement of cash flows. This is where investments other people or businesses make in your business are recorded. In other words, it summarizes cash transactions that involve raising, borrowing, and repaying capital.

For example, if you take out a small business loan, that cash inflow adds to your net cash flow from financing. The same goes if your startup receives venture capital funding or small business grants. As you repay business loans, it lowers your cash flow from financing. As your business grows, if you sell shares or pay dividends to shareholders, those activities are recorded in this section, too.

Going back to our freelance graphic designer example, let’s say she decides to turn her one-woman shop into an agency—and takes out an SBA loan to hire two graphic designers to work with her. The cash she receives from the loan will increase her net cash flow from financing. Later on, she’ll have to repay that loan, and those payments will be recorded in the same section—reducing net cash flow from financing.

Net cash flow

Every statement of cash flows concludes with net cash flow (your ending balance), which represents your change in cash flow over that time. It basically reveals if you earned more cash than you spent (fingers crossed this is the case for you!). It’s calculated by adding:

Net Cash Flow = Net Cash Flow from Operations + Net Cash Flow from Investing + Net Cash Flow from Financing

It’s important to note that your net cash flow isn’t the same as the total cash you have in the bank. It’s a measurement of the change in cash over a given period, and it can be positive or negative. Negative net cash flow doesn’t (necessarily) mean you’re broke or you can’t pay your bills—that’s because it doesn’t take your existing cash balance into account.

For example, if you have:

  • $12,000 in the bank at the beginning of the quarter
  • Net cash flow of –$2,000

You still end the quarter with $10,000 in the bank. That $10,000 is known as “total cash” and it’s included on your balance sheet.

How is cash flow calculated?

We’ve done a lot of talk about calculating cash flow, but haven’t really told you how to do that yet. Fear not, because the time has finally come. There are two ways you can calculate cash flow: the direct method and the indirect method.

The direct method uses the actual cash going into your business (such as cash from customers) and going out of your business (like paying for supplies).

The indirect method starts with your business’s net income, which is then adjusted based on certain factors, like the value of your business assets or any changes to the money you owe or receive.

What is the difference between direct and indirect cash flow statements?

You can use both the direct and indirect methods to calculate your cash flow. The difference between them lies in how your net cash flow is calculated.

The direct method is, well, more direct than the indirect method. The information needed for the direct method (essentially all cash payments and receipts) is more straightforward and transparent, since it includes the actual, "known" amounts of cash you received and spent. For the indirect method, the cash coming in and going out of your business doesn’t have to be “known.”

So, which method should you go with? There’s no right or wrong answer. The direct method is easier to understand, but the indirect method is actually faster. Additionally, the indirect method is the more popular way to calculate cash flow and can be useful for reconciliation. But if you use the cash basis accounting method or are a smaller business, then the direct method might be easier for you.

Limitations of the cash flow statements

Context is important when evaluating your cash flow statements. For example, a negative cash flow might not necessarily mean you’re in trouble—you could just be in the middle of scaling or investing in your business, which should hopefully pay off in the future. 

Although it is a powerful way to understand how your business is performing, the cash flow statement also isn’t enough on its own—you should also consult your income statement and balance sheet to get a fuller picture of your business’s health.

How is a cash flow statement different from an income statement? 

Your cash flow statement isn’t the same as an income statement, but they feed into each other. For example, the net profit or loss on your income statement is used to calculate cash flow from operations, if you’re using the indirect method. The two financing statements differ because they show different information: your income statement gives you insight into your business through revenue, expenses, and profits, while your cash flow statement focuses on the money flowing into and out of your business. 

Other financial statements, like your income statement and balance sheet, include transactions that don’t actually affect the balance in your bank account (or don’t affect it yet). The net income reported on your income statement, for example, includes revenue you earned but haven’t received yet.  

Your statement of cash flows takes information from both of those financial statements and reconciles it with the money flowing into and out of your actual bank account—so it gives you a different perspective on the business’s financial health.

How is a cash flow statement different from a balance sheet? 

A cash flow statement isn’t the same as a balance sheet, but is linked to your income statement and your cash flow statement. Balance sheets differ from cash flow statements because they show information about your assets, liabilities, and capital, while your cash flow statement focuses on the money going into and out of your business. 

The total cash listed on your balance sheet gives only a snapshot of your cash balance on a particular day—it doesn’t help you understand how that number changes based on business activities, unlike the cash flow statement.

Example of a cash flow statement 

Here’s a cash flow statement from a (very made-up) business called Capybara Emporium. In the 2022 fiscal year, their net cash flow is $2,456,189 (meaning: their cash flow is positive, so business is good!). Investors would be particularly interested in the information about net cash flow (to see if business is boomin’), investing (can the business afford to grow itself?), and the amount of cash available (to confirm that the business can pay back any loans it may need.)

Moving forward with the cash flow statement

When you look beyond the numbers and accounting jargon, your statement of cash flows is actually just a simple calculation of the financial health of your business.

Are you bringing in more cash than you spend? That’s what performance comes down to for many small business owners—and understanding your cash flow statement is one way you can take ownership of those numbers and build long-term financial health and business success.

Hot tip (and self-promo time): an easy and beginner-friendly way to see all your business insights in one place is through Wave’s small business accounting software. It helps you simplify your business finances and make better business decisions. 

Now that you’re armed with a better understanding of cash flow statements, you’re empowered to get out there and prepare your own cash flow statement… and keep your business healthy!

By Kiera Abbamonte

The information and tips shared on this blog are meant to be used as learning and personal development tools as you launch, run and grow your business. While a good place to start, these articles should not take the place of personalized advice from professionals. As our lawyers would say: “All content on Wave’s blog is intended for informational purposes only. It should not be considered legal or financial advice.” Additionally, Wave is the legal copyright holder of all materials on the blog, and others cannot re-use or publish it without our written consent.

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