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How to prepare and manage a cash flow statement

Want to create a financial snapshot of your business? While understanding profit and loss is important, it doesn’t tell you the whole story. After all, a significant amount of business takes place without any money changing hands, and the actual exchange of cash may happen after the profit/loss is recorded. To gain a deeper understanding of the cash and cash equivalents that come in and out of your business, a cash flow statement is crucial. How do you prepare a cash flow statement? Read on for more.

What is a cash flow statement?

A cash flow statement is a financial statement that summarises the amount of cash that enters and leaves your business, giving you more information about the amount of working capital that’s available over a given period. It includes all the cash brought in from sales, but not sales made on credit that haven’t actually been paid for. Similarly, it won’t show raw materials and other items that have been purchased on credit but not paid for. In short, cash flow statements are a measurement of how well a company is able to generate cash to fund operating expenses and pay debt obligations

What do cash flow statements show?

A cash flow statement provides insight into changes in your cash on hand. This means that it covers three key aspects of your business activities. These are as follows:

  • Operating activities – This refers to regular business activities. Inflows include revenue from selling products or services, dividends received by the business, interest, and other cash receipts, Outflows include payroll, overheads, taxes, and payments to suppliers and vendors.

  • Investing activities – This refers to gains and losses from investments. Inflows include sales from business assets and payments from loans made by your business, Outflows include purchases of assets and loans made by your business.

  • Financial activities – This refers to capital that’s raised externally. Inflows include any money that’s been borrowed, as well as sales of your company’s securities. Outflows include dividend payments and servicing debt.

Why are cash flow statements important?

Cash flow statements are important for a variety of reasons. Mostly importantly, companies need to be aware of their cash position. If you don’t have a handle on your cash flow, you may not be able to spot trends in your cash flow management that could have a significant effect on your business’s financial health. For example, while your business may appear profitable, slow invoice collections may create a bottleneck that stops you from meeting your financial obligations. To get an accurate picture of your cash flow, you’ll need to produce a cash flow statement.

Cash flow statement format

There are two ways to prepare a cash flow statement: the direct method and the indirect method:

  • Direct method – Operating cash flows are presented as a list of ingoing and outgoing cash flows. Essentially, the direct method subtracts the money you spend from the money you receive.

  • Indirect method – The indirect method presents operating cash flows as a reconciliation from profit to cash flow. This means that depreciation is factored into your calculations.

While both the direct and indirect cash flow statement format provides you with the same end result, it’s important to note that the International Accounting Standards Board (IASB) favours the direct method, as it provides more useful information. If you’re based in the UK, you’ll need to create a cash flow statement that meets international financial reporting standards (IFRS), so the direct method may be the best option for your business.

How to prepare a cash flow statement

While cash flow statements may appear complex, they’re not too difficult once you have a system in place. Here’s how to prepare a cash flow statement:

  1. Gather important documents – First, you need to obtain your balance sheet, a statement of comprehensive income, a statement of changes in equity, a statement of cash flows for the previous reporting period, and information about any material transactions made by your company during the current period (sources can include contracts, legal files, investment documents, etc.).

  2. Calculate changes in the balance sheet – Next, you need to work out any changes to your balance sheet over the current period. You can do this by looking at all your assets, equities, and liabilities, and subtracting the closing balance sheet figure from the opening balance sheet figure.

  3. Put all balance sheet changes on your statement of cash flows – Next, you should look at all the changes you recorded in the previous step and enter them into a blank cash flow statement. Be sure to place them in the appropriate section (i.e. operating activities, investing activities, or financial activities).

  4. Adjust for non-cash items – You’ve now got a rudimentary cash flow statement, but you need to identify any potential non-cash items that may have been recorded on the balance sheet. For instance, this could be depreciation expenses, income tax expenses, foreign exchange differences, and so on. Once you’ve identified a non-cash transaction, just make an adjustment to the cash flow statement.

  5. Do final calculations – Now, you need to sum up all the individual entries, calculating the overall change in the balance sheet while adjusting for non-cash items, which provides you with the total cash movement for that item.

Cash flow statement examples

As you can see, a cash flow statement can be fairly complicated. It may help to look at a real-world cash flow statement example to see how they work in practice. There are a broad range of cash flow statement examples available online – for instance, this one from the Corporate Finance Institute – so you can take plenty of time to dig into how cash flow statements work before you produce your own.

Cash flow vs. profit and loss statement

One issue that can trip people up is the difference between a cash flow statement and a profit and loss statement. At first glance, these financial documents appear to have many similarities, but there are a couple of key differences. Put simply, profit and loss statements don’t show every detail of your ingoing and outgoing financial activities, whereas cash flow statements do. Instead, profit and loss statements show overall profits over a given period, detailing sources of income and expenses.

For example, a profit and loss statement won’t show credit card payments or loan payments, because they aren’t considered to be expenses, even though they represent cash leaving your business. When it comes to cash flow vs. profit and loss statements, cash flow is generally a better indicator of the short-term health of your business, whereas profit and loss statements can give you a little more insight into your company’s financial standing over a longer period of time.

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GoCardless (company registration number 07495895) is authorised by the Financial Conduct Authority under the Payment Services Regulations 2017, registration number 597190, for the provision of payment services. GoCardless SAS (23-25 Avenue Mac-Mahon, Paris, 75017, France), an affiliate of GoCardless Ltd (company registration number 834 422 180, R.C.S. PARIS), is authorised by the ACPR (French Prudential Supervision and Resolution Authority), Bank Code (CIB) 17118, for the provision of payment services.