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Understanding the Cash Flow Statement

Whether you’re a business owner, manager, or investor, understanding cash flow helps you make more informed financial decisions. Here’s how to interpret the cash flow statement, even if you’re not a professional accountant. We’ll start with the cash flow statement definition below, followed by a breakdown of what it all means.

Cash flow statement definition

Along with the balance sheet and income statement, the cash flow statement is an important document outlining a business’s financial position. This financial statement displays aggregate data pertaining to all of the company’s cash inflows, received from operations, investment sources, and financing.

It also shows you all cash outflows during the same period so you can see how business operations and investments are paid for. The sum of all components is called the net cash flow, which is a key figure when assessing business value.

Purpose of cash flow statement

Do you know exactly where your business’s cash is going? The purpose of the cash flow statement is to give a detailed picture of cash inflow and outflow during any accounting period. In doing so, it shows how successful the business is when it comes to financing its own operations. If there’s enough cash coming in to pay for business activities without additional financing, this is an indicator of financial health.

An investor might be wary of a company with unstable cash flow, or they might be interested in a company displaying continuous positive inflows. The cash flow statement can also be used internally to make budgeting and hiring decisions.

When looking at the purpose of a cash flow statement, it’s often described as being either positive or negative.

  1. Positive cash flow means that the business is taking in more cash than it’s spending. This means it can grow by paying off debts and putting extra cash back into the company.

  2. Negative cash flow means the business is spending more cash than it’s taking in. This means that income and expenditures are mismatched, which is something the business owner needs to address.

Components of the cash flow statement

There are three primary components of the cash flow statement format, including:

  1. Operating activities: cash flow generated by delivering goods and services, including revenue and expenses.

  2. Investing activities: cash flow generated from acquiring or selling assets like real estate, company vehicles, and patents.

  3. Financing activities: cash flow obtained from equity financing as well as debt, including company loans.

How to calculate cash flow

How can you determine whether a business’s cash flow is positive or negative? There are two methods to choose from. Here’s how to calculate cash flow:

Direct Method: This method uses all transactions from the operation section of the cash flow statement. You subtract all cash outflows from all cash inflows received from these operating activities, finding out how much cash is left over.

Indirect method: Using the indirect method, you base your calculations on the accrual method of accounting. In other words, revenue and expenses are recorded at different times other than when the cash is received in your account. This method factors in accrual entries and adjustments.

Cash flow statement example

There’s no single cash flow statement format you must use when drawing up your cash flow statement, but generally accountants will divide it into three sections:

  1. Operating activities

  2. Investing activities

  3. Financing activities

Under each section, you will see an itemised list of cash flowing in and out of the business accounts. These are tallied together to show you the final amount of cash, either positive or negative, for the accounting period in question. Here’s a cash flow statement example to show what that might look like:

CASH FLOW STATEMENT

COMPANY XYZ

MONTH ENDING 31 JANUARY 2021

Cash Flow from Operations

 

Net Income

£50,000

Additions to cash

 

Accounts Payable Increase

£10,000

Depreciation

£5,000

Subtractions from cash

 

Accounts Receivable Increase

(£5,000)

Inventory

(£8,000)

Net Cash from Operations

£52,000

 

 

Cash Flow from Investing

 

Purchase of supplies

(£5,000)

 

 

Cash Flow from Financing

 

Repayment of loan

(£5,000)

 

 

Cash Flow for End of Month

£42,000

As you can see from this simple cash flow statement example, the company has a positive cash flow of £42,000 at the end of the month after factoring in cash flows from the three sections. While both financing and investing involved cash outflows, this was made up for the overall positive inflow from operations. The company is in good financial health for this accounting period.

By showing you how a business is spending its money and what it has to work with, the cash flow statement gives vital insight into daily operations.

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