Understanding Cash Flow Statement – Definition and Examples

A cash flow statement tells you how much cash is entering and leaving your business. Along with balance sheets and income statements, it’s one of the three most important financial statements for managing your small business accounting and making sure you have enough cash to keep operating.

First, let’s take a closer look at what cash flow statements do for your business, and why they’re so important. Then, we’ll walk through an example cash flow statement, and show you how to create your own using a template.

What is a cash flow statement?

  • A cash flow statement is a regular financial statement telling you how much cash you have on hand for a specific period.
  • While income statements are excellent for showing you how much money you’ve spent and earned, they don’t necessarily tell you how much cash you have on hand for a specific period of time.
  • When you utilize accrual accounting, revenue and costs are recorded when they are generated or incurred, rather than when the money leaves or enters your bank accounts.
  • So, even if you see income reported on your income statement, you may not have the cash from that income on hand. The cash flow statement makes adjustments to the information recorded on your income statement, so you see your net cash flow—the precise amount of cash you have on hand for that time period.
  • Depreciation, for example, is documented as a monthly expenditure. However, you have already paid cash for the item you are depreciating; you record it on a monthly basis to see how much it costs you to have the asset each month during its useful life. However, cash does not physically leave your bank account every month.
  • The cash flow statement reverses that monthly expenditure, allowing you to see how much cash you have on hand in actuality rather than how much you’ve spent in theory.

Why do you need cash flow statements?

So long as you use accrual accounting, cash flow statements are essential for three reasons:

  1. They show your liquidity Which means you know exactly how much operating cash flow you have in case you need to use it. So you know what you can afford, and what you can’t.
  2. They show you changes in assets, liabilities, and equity in the forms of cash outflows, cash inflows, and cash being held. Those three categories are the core of your business accounting. Together, they form the accounting equation that lets you measure your performance.
  3. They let you predict future cash flows. You can use cash flow statements to create cash flow projections, so you can plan for how much liquidity your business will have in the future. That’s important for making long-term business plans.

On top of that, if you plan on securing a loan or line of credit, you’ll need up-to-date cash flow statements to apply.

Negative cash flow vs. positive cash flow

When your cash flow statement shows a negative number at the bottom, that means you lost cash during the accounting period—you have negative cash flow. It’s important to remember that, long-term, negative cash flow isn’t always a bad thing. Some months you may spend cash in order to make money later on—by investing in equipment, for example.

When you have a positive number at the bottom of your statement, you’ve got positive cash flow for the month. Keep in mind, positive cash flow isn’t always a good thing in the long term. While it gives you more liquidity now, there are negative reasons you may have that money—for instance, by taking on a large loan to bail out your failing business. Positive cash flow isn’t always positive overall.

Statements of cash flow using the direct and indirect methods

You have two options for calculating your company’s cash flow: the direct technique or the indirect method. While both are approved by generally recognized accounting standards (GAAP), small enterprises frequently favor the indirect route.

The direct method of calculating cash flow

Using the direct method, you keep a record of cash as it enters and leaves your business, then use that information at the end of the month to prepare a statement of cash flow.

The direct method takes more legwork and organization than the indirect method—you need to produce and track cash receipts for every cash transaction. For that reason, smaller businesses typically prefer the indirect method.

Also worth mentioning: Even if you record cash flows in real-time with the direct method, you’ll also need to use the indirect method to reconcile your statement of cash flows with your income statement. So, you can usually expect the direct method to take longer than the indirect method.

The indirect method of calculating cash flow

With the indirect method, you look at the transactions recorded on your income statement, then reverse some of them in order to see your working capital. You’re selectively backtracking your income statement in order to eliminate transactions that don’t show the movement of cash.

Since it’s simpler than the direct method, many small businesses prefer this approach. Also, when using the indirect method, you do not have to go back and reconcile your statements with the direct method.

In our examples below, we’ll use the indirect method of calculating cash flow.

How the cash flow statement works with the income statement and the balance sheet

You use information from your income statement and your balance sheet to create your cash flow statement. The income statement lets you know how money entered and left your business, while the balance sheet shows how those transactions affect different accounts—like accounts receivable, inventory, and accounts payable.

So, the process of producing financial statements for your business goes

Income Statement + Balance Sheet = Cash Flow Statement

Example of a cash flow statement

Now that we’ve got a sense of what a statement of cash flows does and, broadly, how it’s created, let’s check out an example.


There’s a fair amount to unpack here. But here’s what you need to know to get a rough idea of what this cash flow statement is doing.

  • Red dollar amounts decrease cash. For instance, when we see ($30,000) next to “Increase in inventory,” it means inventory increased by $30,000 on the balance sheet. We bought $30,000 worth of inventory, so cash decreased by that amount.
  • Black dollar amounts increase cash. For example, when we see $20,000 next to “Depreciation,” that $20,000 is an expense on the income statement, but depreciation doesn’t actually decrease cash. So we add it back to net income.

You’ll also notice that the statement of cash flows is broken down into three sections—Cash Flow from Operating Activities, Cash Flow from Investing Activities, and Cash Flow from Financing Activities. Let’s look at what each section of the cash flow statement does.

The three sections of a cash flow statement

These three sections of the statement of cash flows designate the different ways cash can enter and leave your business.

  • Cash Flow from Operating Activities cash earned or spent in the course of regular business activity—the main way your business makes money, by selling products or services.
  • Cash Flow from Investing Activities is cash earned or spent from investments your company makes, such as purchasing equipment or investing in other companies.
  • Cash Flow from Financing Activities is cash earned or spent in the course of financing your company with loans, lines of credit, or owner’s equity.

Using the cash flow statement example above, here’s a more detailed look at what each section does, and what it means for your business.

Cash Flow from Operating Activities

Taking another look at this section, let’s break it down line by line.

Net income is the total income, after expenses, for the month. We get this from the income statement.

Depreciation is recorded as a $20,000 expense on the income statement. Here, it’s listed as income. Since no cash actually left our hands, we’re adding that $20,000 back to cash on hand.

Increase in Accounts Payable is recorded as a $10,000 expense on the income statement. That’s money we owe—in this case, let’s say it’s paying contractors to build a new goat pen. Since we owe them money but haven’t actually paid it, we add that amount back to the cash on hand.

Increase in Accounts Receivable is recorded as a $20,000 growth in accounts receivable on the income statement. That’s money we’ve charged clients—but we haven’t actually been paid yet. Even though the money we’ve charged is an asset, it isn’t cold hard cash. So we deduct that $20,000 from cash on hand.

Increase in Inventory is recorded as a $30,000 growth in inventory on the balance sheet. That means we’ve paid $30,000 cash to get $30,000 worth of inventory. Inventory isn’t an asset, but it isn’t cash—we can’t spend it. So we deduct the $30,000 from cash on hand.

Net Cash from Operating Activities, after we’ve made all the changes above, comes out to $40,000.

Meaning, even though our business earned $60,000 in October (as reported on our income statement), we only actually received $40,000 in cash from operating activities.

Cash Flow from Investing Activities

This section covers investments your company has made—by purchasing equipment, real estate, land, or easily liquidated financial products referred to as “cash equivalents.” When you spend cash on investment, that cash gets converted to an asset of equal value.

If you buy a $10,000 mower for your landscaping company, you lose $10,000 cash and get a $10,000 mower. If you buy a $140,000 retail space, you lose $140,000 cash and get a $140,000 retail space.

Under Cash Flow from Investing Activities, we reverse those investments, removing their cash on hand. They have cash value, but they aren’t the same as cash—and the only asset we’re interested in, in this context, is currency.

For small businesses, Cash Flow from Investing Activities usually won’t make up the majority of cash flow for your company. But it still needs to be reconciled, since it affects your working capital.

Cash Flow from Investing Activities in our example

Purchase of Equipment is recorded as a new $5,000 asset on our income statement. It’s an asset, not cash—so, with ($5,000) on the cash flow statement, we deduct $5,000 from cash on hand.

Cash Flow from Financing Activities

This section covers revenue earned or assets spent on Financing Activities. When you pay off part of your loan or line of credit, money leaves your bank accounts. When you tap your line of credit, get a loan, or take bring on a new investor, you receive cash in your accounts.

Cash Flow from Financing Activities in our example

Notes Payable is recorded as a $7,500 liability on the balance sheet. Since we received proceeds from the loan, we record it as a $7,500 increase to cash on hand.

Cash flow for the month

Our entire cash flow for the month is shown at the bottom of our cash flow statement: $42,500.

Despite the fact that our net income was $60,000 (as indicated at the top of the cash flow statement and obtained from our income statement), we only got $42,500.

That is $42,500 that we can spend right now if necessary. If we simply looked at our net income, we’d think we had $60,000 in cash. In such an event, we’d have no idea what we have to work with, and we’d risk overpaying or misrepresenting our liquidity to loan officers or business partners.

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