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Understanding and managing your company’s cash flow is critical for any small business to succeed. That’s why a cash flow statement is essential for small business accounting: It’s a financial statement that shows all the cash coming in and out of your business.

A cash flow statement is one of the three primary financial statements that all businesses need, in addition to the balance sheet and income statement. We break down the differences between these statements below. But first let’s dive into what the cash flow statement tells you, how to use it to analyze your business’s performance, and how it can help you identify any cash flow problems.

What Does a Cash Flow Statement Show?

A cash flow statement shows a company’s cash transactions (inflow and outflow) within a specified period. Many small business owners make the mistake of focusing on profit and loss. But the cash flow statement is what tells them where money is coming from and how it’s being spent, which can help them make better business decisions. The cash flow statement is also essential for investors, as it measures the financial health of a business.

The cash flow statement follows cash inflow and cash outflow for business operations, investments, and financing. Net cash flow is the sum of those three, and below is a description of what each section covers.

Cash flow from operations

This part of a cash flow statement covers the cash flow from operating activities. This includes buying and selling inventory and supplies, salaries, office space rent, income tax payments, and all other operational expenses.

Cash flow from investing

Cash flow from investing includes changes in cash, referred to as cash out or cash in, representing long-term or short-term investments in the company’s growth. This could be purchasing or selling equipment, real estate, vehicles, patents, and other assets a company uses or could sell.

Cash flow from financing

Cash flow from financing summarizes the sources of cash from investors and banks and the money paid to shareholders. This includes cash obtained or paid back from capital fundraising efforts, dividends paid to investors, payments for stock repurchases, and loan repayments. Its source is typically from debt or equity.

How to Use a Cash Flow Statement

The cash flow statement is used not only to show the amount of cash generated and spent over a specific period but also to analyze a business’s liquidity and long-term solvency. The summary of all cash transactions will show either a positive or negative cash flow. 

Positive cash flow means more money is coming in than going out. However, a positive cash flow does not always indicate that the business is profitable. It could have a positive cash flow from borrowing activities but a negative net income. Still, when showing a positive cash flow, excess cash could be reinvested in the business’s growth.

A negative cash flow means more cash is going out than coming in. That is sometimes a good thing, especially if it’s due to investments in future growth. However, a negative cash flow showing for several accounting periods could be a red flag for the company’s financial health. 

How to Identify Cash Flow Problems

The cash flow statement is a critical tool for controlling a company’s cash flow and ensuring that it has enough liquidity to fulfill its short-term obligations, like payroll and other ongoing expenses.  

Analyzing incoming and outgoing cash transactions helps a small business owner make informed decisions. It also helps them anticipate problems, whether having funds to pay off debts or determining eligibility for a business loan.

The cash flow statement also helps a business maintain its optimum level of cash on hand. If money is lying idle, a business could use those funds for growth, like purchasing more inventory or hiring staff. But if the cash flow statement shows a shortage of funds, then borrowing money or cutting expenses may be necessary to keep the business afloat until it can turn a profit.

How Do You Calculate Cash Flow?

Cash flow is calculated using the direct method or the indirect method. Both methods tell the same story of how cash flows through the business, but each does it from a different starting perspective.

Direct cash flow method

Using the direct cash flow method, you would subtract all cash payments made to suppliers, employees, and other operational and customer receipts from a specified accounting period. This gives the net cash outflow from the company’s operating expenses. Investing and financing activities are included after the operations net cash flow to calculate the net change in the company’s cash flow for that period.

The direct cash flow method uses real-time figures to show actual payments and receipts. It’s simple to understand but can be complex to calculate because it requires a list of all cash receipts and disbursements, which can take time and effort. Small businesses with fewer cash transactions typically use the direct cash flow method.

Indirect cash flow method

The indirect cash flow method shows how much cash the business spent or made during the accounting period. It takes the company’s net income and adds or subtracts differences from non-cash transactions, including changes in current liabilities, assets, and other sources on the balance sheet, like non-operating losses or gains from non-current assets.

The indirect cash flow method makes adjustments for non-operating expenses to determine the cash flow for operating expenses. Examples of these adjustments are adding the decrease in accounts receivable, deducting the decrease in accounts payable, or deducting the increase in inventory.

Public companies often use the indirect cash flow method. As it uses information from income statements and balance sheets, it’s quick to calculate and comes in handy for audits. 

How a Cash Flow Statement Differs from Other Financial Statements

The cash flow statement measures your business’s performance over a period of time by reporting its cash inflows and outflows. Its bottom line shows the net increase or decrease for that accounting period. 

The income statement shows how much money the business made and spent over the accounting period and the costs and expenses associated with earning that income. Its bottom line shows the company’s net earnings or losses for that period.

A balance sheet shows what a business owns and owes at a fixed point in time. It includes detailed information on the company’s assets, liabilities, and shareholder assets. The balance sheet uses the equation of “assets = liabilities + shareholders’ equity.” So its assets have to equal (or balance) the sum of its liabilities and shareholders’ equity.

How the financial statements relate

Each financial statement shows a different picture, but they are still related. For instance, the changes in assets and liabilities included on the balance sheet are also shown in the revenues and expenses included on the income statement, which result in the business’s gains or losses. 

The image below is courtesy of the Corporate Finance Institute.

Cash flow statements provide more information on the cash assets listed on the balance sheet. They are related, but not equivalent, to net income shown on the income statement, and so on. 

When all three of these financial statements are combined, they provide a complete picture of a company’s financial standing. They also come in handy when preparing your tax returns.

The Oregon SBDC Network provides classes on small business accounting methods, cash flow management, budgeting, and QuickBooks—a cloud-based mobile (or online) app for financial reporting and management that many small businesses favor. To find a small business accounting or QuickBooks class near you, contact your local Center today.

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